LendingClub Corporation (LC) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the LendingClub's Third Quarter 2017 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Artem Nalivayko, Investor Relations Manager. Please go ahead.

Thank you, and good afternoon. Welcome to LendingClub's Third Quarter of 2017 Earnings Conference Call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO; and Tom Casey, CFO. Before we get started, I'd like to remind everyone that this is a conference call is being broadcast on the Internet. We have provided a slide presentation to accompany our commentary, and both the presentation on the call are available through the Investor Relations section of our website at ir.lendingclub.com. Also, our remarks today will include forward-looking statements that are based on our current expectations, forecasts and assumptions and involve risks and uncertainties. These statements include, but are not limited to, our guidance for the fourth quarter and full year 2017. Our actual results may differ materially from these contemplated by these forward-looking statements. Factors that could cause these results to differ materially are described in today's press release, in the related slide presentation on our Investor Relations website and our most recent Form 10-K and Form 10-Q filed with the SEC. Any forward-looking statements that we will 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. Also during this call, we will present and discuss both GAAP and non-GAAP financial measures. Further, all operating expenses that we will discuss excludes stock-based compensation, depreciation and amortization. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release and investor presentation. And now, I'd like to hand the call over to Scott.

All right. Thank you, Artem. Good afternoon, everyone. I am pleased that we continued our momentum and delivered on our promise of back-to-back growth this quarter. Our ambitious goals in Q3 required strong execution to take full advantage of the seasonably favorable quarter, and we succeeded, capturing the increasing demand on both sides of our marketplace. First, a quick look at the financial highlights. In Q3, we delivered $154 million in revenue, the highest in the company's history, and up 34% year-over-year, and 10% sequentially. As importantly, we generated an EBITDA of $21 million. That's almost 5x the level of last quarter. And we've narrowed our GAAP losses by almost $19 million, down to $6.7 million. On the borrower side of the platform, demand continues to remain incredibly high. We processed a record number of applications, bringing the total borrowers served by Lending Club to over 2 million since launch and an improved efficiency from last quarter. To put that into perspective, it took 8 years for us to reach our first 1 million, and we've helped an additional 1 million borrowers in just the last 2 years. That's because we offer something truly of value. Researches from the Federal Reserve recently published a study based on LendingClub data, which concluded that our business model plays a role in selling the credit GAAP and enhances financial inclusion by reaching geographies and borrowers that traditional programs may overlook or overcharge. Demand was similarly high on the investor side of the platform where we launched our second securitization. It was an oversubscribed deal, and we captured significant economics that Tom will break down for you later in the call. Given our scale and industry leader position, I believe it is crucial that we keep a pulse on the overall environment that we are operating in, particularly in how it affects our borrowers. We express our heartfelt sympathies to the millions of Americans who have their lives disrupted by natural disasters, from hurricanes to wildfires. At LendingClub, we responded quickly, with the support of our platform investors, to do the right thing and offer payment relief solutions to our borrowers to help them avoid further financial burden. While the impact to individual lives is significant, and we will see a short-term impact on our marketing efforts as those areas recover, we don't expect a long-term impact on marketing or investor returns from these natural disasters. In addition, in the quarter, the significant data breach at Equifax has put consumers on edge. An increase in credit freezes will have some small impact on the business in the near term, but we have not seen any material increase in fraud. In the broader environment, the economy remains healthy with growth in GDP and continued low unemployment. At the same time, consumer debt levels have continued to increase as credit supply has returned to the market and losses have risen from their post-recession lows. We would note that this is not a new trend for the industry, and we first discussed credit normalization in Q1 2016 earnings call. We believe we are well-positioned today to manage in this environment due to our efforts regarding credit, which I would like to discuss in more detail. Throughout 2016, and in January of this year, we implemented a series of adjustments to tighten the parameters at the edges of credit in our prime portfolio. Earlier this year, we also started working on the next-generation credit model to better capture the evolving landscape. In September, we launched this new model onto our enterprise positioning platform, and we believe it is a significant step forward. Importantly, we built it using LendingClub's recent performance data, and we deployed the latest machine learning techniques to derive more than 100 customized and behavioral attributes, nearly half of which are proprietary to LendingClub and based on our unique data assets. This sophisticated model does not rely on FICO scores and evaluates credit and trends in a much more granular level than our last-generation model. For example, we now look at a borrower's credit behavior over time instead of a snapshot and create a detailed picture of their profile versus using simple aggregates. We believe that this new model is better-adapted to today's credit environment and enables us to give borrowers the credit they deserve while delivering the yield investors expect. In our prime portfolio, this new model does represent a tightening, with an overall shift to higher-quality grades and higher-quality approvals within grades. In addition, and as part of our approach, we're proactively taking the decision to tighten the volume of our SMG grade loans, which represent about 3% of total loans and our highest -- risk segment in prime as they are not currently meeting our expectations. In addition, we are temporarily not making these loans available to investors while we conduct a series of product and price tests designed to reduce defaults in prepayments and deliver a better outcome for our borrowers and investors. Although we anticipate some short-term volume effects as we calibrate our targeted marketing to the new model, the 58% annual growth in applications we saw in Q3, combined with the conversion efforts we now have in testing, give me confidence about our outlook in 2018. One of the successful conversion efforts that was introduced this year after extended testing last year is joint application, which continues to ramp up to a broader borrower base. Joint applications now represent 13% of the population, up from 5% when we first introduced the feature, and we continue to see solid response. Because we are tracking 2 sets of income here, we can offer borrowers both a lower rate and access to more credit while simultaneously lowering the risk for investors. We have a number of new and unique product and pricing initiatives that are in various phases of testing, and we expect them to be as well-received as joint application when they start to roll out the consumers in Q4 and into next year. While important for borrowers, these product initiatives are equally important for investors so that we can continue to deliver risk-adjusted returns that meet expectations. As part of our quarterly updates, you will note that for the significant majority of our customers in both prime and near-prime, our forecast show losses and returns to investors largely unchanged from last quarter. Separately, we continue to broaden our mix of investors. As part of that, we delivered on our goal to complete a second securitization that included a total of 33 investors, 10 of which were new to the LendingClub platform. Combined with our first securitization in Q2, these activities have brought in a total of 30 new investors and given LendingClub access to a stable, scalable and diverse school of capital. For these new investors, our capital markets capability provides them with ongoing liquidity, increased transparency and consistent access to our marketplace and a structure that suits them best. As we progress, our funding diversity will continue to evolve. When looking at the investor mix driving originations in Q4, you will see growth coming from institutional investors as we ramp up our efforts to deliver securitizations and other structured products as well as from LendingClub as we accumulate loans to securitize. You will also see a decline in bank participation due to the successful conclusion of a year-long agreement with Credigy, a subsidiary of the National Bank of Canada. This was a great partnership that we've put in place very soon after the events of last year to bridge us while the traditional banks were in the process of returning to the platform and while we built up our new investor capabilities. While we continue to maintain a great relationship with Credigy, we are in a different situation today as we have all of our regional banks back on the platform and we have added 14 new ones in 2017. So we feel great about our current mix of investors, and we have more exciting initiatives in the pipeline to broaden our investor base that we look forward to sharing with you at our Investor Day on December 7. Overall, we are pleased with the progress that we're making in our core business while we simultaneously continue to resolve the remaining issues stemming from the events of last year. Before I hand over to Tom, I wanted to highlight two other items with potential for a Q4 impact, first is the successful sale of assets from our legacy LCA funds. While we incurred some costs with the sale, we are pleased with the outcome for both our LCA investors exiting our investment and those that will continue with our new funds. The second is the planned mediation on November 28 related to a securities class action lawsuit. It's possible that this will settle by the end of the year, which will mark another major step forward in putting the events of 2016 behind us. In closing, we are pleased with our third quarter results. We saw increased demands on both sides of the marketplace. This demonstrated the strength of our core business as we delivered on the biggest revenue in our company's history. Over the last year, we've shown the power of the model and have made proactive and deliberate investments to manage the business in an evolving environment. As we enter a historically slower season, we're confident in our conversion efforts and product roadmap for both borrowers and investors. The foundation is here. We have an incredible team, a proven ability to innovate and a massive market to tackle. I look forward to seeing many of you at our Investor Day on December 7, in New York, where we'll share our full 2018 guidance, our long-term vision, strategy and financial plan. And with that, I'll turn it over to Tom, to provide the details on our Q3 financials and outlook for Q4.

Thanks, Scott. I'm pleased to report another quarter in which we executed against our plan. And as Scott mentioned, this marks the highest revenue quarter in our history, with revenue up 34% annually and up 10% sequentially to $154 million. In the third quarter, we can see our focus on execution bearing fruit in the form of revenue growth, improved contribution margin, significant EBITDA expansion as well as some positive third quarter seasonal impacts. Now let's turn to the financial results. Total originations for the quarter grew 14% sequentially to over $2.4 billion, driving transaction fees up $15 million from 2Q and accounted for substantially all of our revenue growth for the third quarter. The sequential changes in the rest of our income lines largely offset, with the interest income netted against the market value adjustment to loans held on the balance sheet. Revenue from the third quarter prime securitization activities were $2.6 million compared to $3.7 million for our non-prime securitization in 2Q. Costs were a little higher than our Q2 deal, attributable, in part, to our increased share of total expenses from our direct contribution of loans to the pool for the first time. We expect total program costs to come down over time as we firmly establish the program and achieve efficiencies and scale. Before I get to the details related to the securitization, let me point you to Page 16 of our earnings presentation. A couple things to remember. The third quarter transaction was a prime securitization, and we contributed $98 million of loans we purchased directly from the platform. As you look at Page 16 of our earnings presentation, you should consider the first 2 line items in the right-hand column netting for a favorable impact of $1.6 million, attributable to the setup in servicing rate from loans contributed into securitization. Next, you can see that the program fees were offset by program costs. And lastly, $2.7 million of net interest income is netted with a positive $190,000 fair value adjustment for a favorable $2.9 million impact. Overall, the securitization program added about $2.6 million in net revenue for the third quarter. Now let's look at our contribution margin. I'm very pleased to come in at the high end of our 45% to 50% target as we were able to drive contribution margin of 49%, up from 47% in the second quarter. The increase reflects our securitization as well as continued improvements in conversion and testing, marketing initiatives and scale efficiencies. The increased results were aided by a favorable seasonality we typically observe in the third quarter. Sales and market expenses was $58 million, or 2.37% of originations, down 13 basis points sequentially as efficiency in M&S continues to be a key focus for us. Two things showed the benefit this quarter, first, we benefit from our efforts to reposition our technology and productivity initiatives in the patient finance business; and second, we continue to drive productivity in personal loans through our own strategic conversion efforts. I will note and expect marketing efficiency next quarter to reflect the seasonality we typically observe in the fourth quarter as well as some additional costs associated with fine-tuning our marketing channels to the new credit model. So I expect M&S efficiency to be at about Q1 levels being earlier this year. Origination servicing expenses in the third quarter were $20.3 million, in line with the second quarter. As you may recall, we ramped up staffing for growth earlier in the year, and we are seeing the benefit come through as sequential spend remain flat despite 40% volume growth in the third quarter. We've already begun to build up our O&S capabilities, heading in for 2018. We also saw improvements in our engineering expenditure by compensation expense, particularly the runoff of the retention agreements. We are investing in new data and product initiatives and have several new product features and capabilities that we look forward to sharing at our Investor Day next month. Turning to G&A. Costs were $35.8 million for the quarter. We feel great about G&A coming down over 5 points this quarter to 23% of revenue, our lowest level since Q1 of '16. As you may recall, we have had nonrecurring expenses and insurance recoveries impacting this line throughout the year. Our nonrecurring expenses this quarter came down to $6.4 million and were largely offset by $7.1 million in insurance recoveries. With the nonrecurring expenses and insurance recoveries roughly offsetting this quarter, we begin to see a more normalized level of G&A expense, which you can see positively impacting our adjusted EBITDA. As we go forward, these nonrecurring legal cost and related recoveries are difficult to forecast, and expect them to continue and have some impact on our quarterly results. We will do our best to forecast them but we'll continue to call them out separately so you can see our ongoing G&A expense level to support our business. On the back of our operating efficiency in the third quarter, our adjusted EBITDA margin grew 10.4 points sequentially to 13.6%. The adjusted EBITDA of $20.9 million was almost 5x our Q2 EBITDA of $4.5 million. With our $14 million decrease in net revenue and a $2 million decrease in operating expenses for a total EBITDA increase of over $16 million, the third quarter again demonstrated positive operating leverage as our business continues to scale through revenue growth. Our GAAP net loss had improved to $6.7 million, a $19 million improvement sequentially. Stock-based compensation as a percent of the total net revenue decreased sequentially to 10%, down from 14% in the second quarter as the retention awards given in Q2 of '16 have largely rolled off. Earnings per share came in at a loss of $0.02 per diluted share. We entered the quarter with $604 million of cash and securities available for sale and no debt. We also held about $187 million in loans on the balance sheet, most of which we will use for our fourth quarter securitization. Our capital management strategy looks to utilize our strong balance sheet to complement our diverse investor base. After 2 highly successful securitizations and a stronger-than-anticipated investor appetite, we have observed in the market, we are expanding our planning contribution to securitizations in the fourth quarter. In order to accomplish this, we began accumulating loans on our balance sheet in the third quarter, and we secured a $250 million warehouse line to ensure we remain well within our liquidity target range. We plan to execute 2 securitizations in 4Q, and we are on track to deliver roughly $50 million of securitization-related revenue for the full year. We have received terrific feedback from investors around the value that these structures create and are excited to build this program to meet the market demand. And now I'd like to turn to our outlook for the fourth quarter. There are several important items I like to call out that impact our outlook. As Scott mentioned, we implemented our fifth-generation credit models towards the end of the third quarter. The improved model allows us to assess risk and price borrowers in a more sophisticated way. As a result, we are seeing improved borrower profile for the applicants we approve. While we optimize our targeting marketing strategy and product structures to the increasing mix of higher-grade prime borrowers, the model and our testing in F and G loan categories will serve as a tightening in the near term. It will cause a slight headwind for Q4, but we believe these are the right investments to position ourselves for 2018. The second item I'd like to call out is the successful sale of $402 million of assets in our LCA funds in the fourth quarter. We sold these assets at or above fair value. And while we will incur some costs for the sale, we're very pleased with the outcome for our LCA investors exiting their investments and the investors that chose to participate in our new funds. As And you will notice in our 10-Q filing tomorrow, the last item I would like to call out is a November 28 mediation related to our securities class-action litigation. At this time we cannot make any reasonable estimate whether the matters will settle, and if so, indicate a positive range for any settlement. Any settlement may be covered in whole or in part by our insurance. Reflecting the impact of the new model implementation and the LCA sale, we now forecast total net revenue in the range of $158 million to $163 million, and adjusted EBITDA of $19 million to $23 million. Please note, while 3Q nonrecurring items were largely offset, it's difficult to predict the timing and related recoveries of these expenses. To clarify, as a practice, our 4Q guidance assumes no impact from nonrecurring items, and we will continue to break these items out in our earnings so you can analyze our core fundamentals. Lastly, we expect stock-based compensation, depreciation and amortization will be about $26 million, and GAAP net loss between $7 million to $3 million. Now I'd like to pass it back to Scott for some closing remarks.

Thanks, Tom. So I'll sign off by saying we are pleased with the results in Q3 and are confident we are making the right decisions to manage the business for long-term growth. Recognizing that today is limited both by time and format, I look forward to seeing many of you on December 7 live and in person, where we can share much more detail into where we plan to take the business. So with that, let's move to Q&A.

[Operator Instructions]. Your first question comes from Brad Berning of Craig-Hallum.

Scott, I know you guys want to talk about '18 on the Investor Day, but maybe we can take a step back into Credigy and should we be thinking about growth in '18 to be ex-Credigy? Or do think that there's enough programs in the pipeline that you feel that growing sequentially, relative to more historical normal levels, is something investors should be thinking about?

So I think, taking a step back on Credigy. As you're aware, that particular program made a lot of sense for us at the time we closed it because we're really looking to make sure we had sufficient demand at the time, and banks were going through their diligence process. Now that our historical banks are back and the new banks are back, that kind of a program doesn't really make sense for us. We continue to work with Credigy, but it will be in a different format. And overall, we're quite confident about the level of investor demand we are seeing on the platform given some of the new capabilities in the capital markets and some other loans we plan to share with everybody that we've got some sufficient demand to fund our growth as we look forward.

Appreciate it. And then one follow-up on the LCA funds. You guys talked about some costs in 4Q, but could you be more specific about what those costs are, just so we can think about what adjusted EBITDA expectations were versus where the guidance is currently?

Yes. And that obviously impacted our guidance from what we talked about last quarter. We have been working through a series of things that Scott mentioned, just the governance issues and putting in place a go-forward strategy with the relaunch of those funds. The costs associated with that are really the marketing- and sales-related costs. To get these transactions done, we're currently selling $400 million of assets is obviously a process that we went through. We were encouraged with the number of bidders that came to the table, looking to buy them. So the costs are about $1 million to $2 million associated with that. And that's pretty much directed to the bottom line.

The next question will come from James Friedman of Susquehanna.

Just judging by the questions I'm getting from investors, I guess the elephant in the room was about the Q4 revenue guide. You started the year guiding $565 million to $595 million. If I take the first 9 months and then include the updated Q4 guide, it gets you within that range, $576 million to $581 million. But if you could enumerate for us what's contemplated in the $158 million to $163 million, what it might have been absent some of the callouts, like the revisions related to the F and G credit scores, that would be helpful.

Yes. Sure. I think just on the guidance itself, when we did our original guidance, we felt that we will be able to continue to see growth throughout the quarter. We accelerated the adoption or the rollout of the G5 model. That probably put about, call it, somewhere in the neighborhood of $5 million to $10 million of impact just on the top line. So you're talking about maybe a 5% to 7.5% type of volume number between those two events. So while we're still under the originating F and G, we'll be at a lower level, so we're putting those into our testing portfolio. But you're talking about probably in that $10 million range related to those events and that's the reason for the new guidance.

Okay.

And just to be comprehensive on the -- just to connect the dots on the EBITDA side, it's the LCA cost that originally were in our guide. Either we felt it was prudent to get that done before the end of the year, and so we've accelerated that as well.

I'll just add on the implementation of the new models. Some of these impacts in -- Tom indicated, we made a deliberate decision to accelerate implementation of the model because we've -- based on the profiles we're seeing and our conviction and the power of this model, we think it's the right thing to do to position us for growth for next year. So some of that impact is going to be short-term as we just adjust our marketing targeting models and some of our vehicles to adapt to reach the customers that these new model is bringing in for us.

Okay. And Scott, if you can elaborate on that because that's, I guess, part of the journey of the last, I don't know, couple of years. You started that process to some degree, tightening the credit in '16, I remember in there, the beginning of '17. I know you had some of this in your prepared remarks. But where do we travel to going forward with that? How do we know when we're done?

So I'd say the big thing we're looking at as a distinction here is, in the past, what we are doing was -- so I want just to make sure everyone kind of properly understands the segment we're talking about here. So we've got 2 programs for personal loans, the prime program and the near-prime. Near-prime expectations and performance continues to be in line. And within prime are the high-end of our grades, which represent 80% of our volume in -- overall, also continue to perform in line. So really, what we've been seeing is kind of, let's call it, the edges of the portfolio. So the higher-risk segment of the prime credit population. And what we've been doing is tightening the parameters, adjusting the parameters, kind of on the edges of that old model. This new model is fundamentally a complete refresh using not -- so keep in mind, those -- the prior model would have been built on older data prior to the last couple of years. So this new model is really using recent data, reflecting the current environment and, again, using some new techniques, which is why we feel great about it and why we wanted to accelerated it and get it in. We're seeing great initial results. This will be something, obviously, we'll continue to monitor and share with investors as we progress. I'll say that the demand we're seeing for the asset overall, I think it's something that's a great indicator of the fact that our loan investors believe that we are making the right moves here. And I just want to emphasize that that's what we're solving for here is managing this business for the long-term.

The next question will come from James Faucette of Morgan Stanley.

I wanted to follow up on that question there is when you look at the new credit model and the drag that you think it's putting on the fourth quarter, is that tightening? Do you expect -- will that be a persistent drag through 2018? Or should we expect that you're able to start to apply that and get back to that type of revenue growth run rate that you had been anticipating?

Yes. So I'd say part of this effect is near-term, which, as I've just mentioned, is just us adjusting to, A, you've got to redo your models and retarget some of your marketing models to really find the right customer. And then the other piece, as we indicated, and we look forward to sharing more of this at Investor Day, is we've got a number of enhancements that we've got in testing that we believe will position us well for the current environment and from growth in 2018. I don't know, Tom, if you had anything to add.

I think that's right. I think, near term, this obviously puts some pressure on the originations and also in a slower quarter historically. But we thought it was the right thing to do is to get positioned. I think the key thing is that when you think about some of the new initiatives Scott just indicated, this model allows us to do a lot of those types of things. And so we needed the model to be in place to really start to offer these types of services and products in a more effective way, and so we've got to do both of them. And so as we're testing, like Scott mentioned, the joint app, for example, happens. Some of these things are already in testing. We need this -- the model to be in place to accelerate our growth. So while on short-term, it's a little bit of a -- or kind of a pullback, we think longer term, it will provide us with a lot of opportunity to manage our way through whatever environment we're in.

Got it. So once the retargeting is done and you expect to -- that you can start to improve the growth rates off even with the new model. So I get that. So then my second question is, when you look at the investor participation, really, the banks were good. At least versus our estimates, everybody else fell below. In particular, on the individual side, how should we expect individuals? And what's the work you need to do there to improve individual participation in the platform? And is that even a priority for you?

So just again, this is something we plan to discuss in some more detail in December. But I'd say overall, individual investors do remain an important part of the mix, and we are thinking, quite broadly, about the right ways to reach those investors. Just like you're seeing from us on the institutional side, we're working on some structures that allow people to buy the product in the way they want to buy it. We'll be doing more work there on the retail side as well. As we indicated in the past, those programs do take, well, important. And as a part of the mix, they do take longer to scale. So we'll be talking about those initiatives, and we'll start to see those playing in through the course of next year, but it'll take a while for that, on a percentage basis, to catch up.

The next question will come from Jed Kelly of Oppenheimer.

Great. Is there any way you can quantify the impact the storms had -- and the Equifax breach had on some of your conversion and EBITDA?

Yes. It definitely has an impact, Jed. And we didn't call out specifically. It's in our numbers for the volume I mentioned. It's probably represented probably $25 million to $50 million of that $100 million I mentioned. I mean it's not insignificant. We think it will moderate going forward. But clearly, we were not mailing into storm-related areas in the third quarter. And as we look to what's happening with Equifax, we are seeing some degradation in some of our targeted marketing. So those things will work their way through. But I think, in the short term, we are seeing some impact. It's hard to call out specifics, but it's not -- clearly, not 0. It's probably 30% of what we've been talking here on volume.

And then I think it's been about a year since you launched your auto products. Can you just give an update on how that's progressing?

Yes. So we are in the -- the key thing we've been looking at is performance of credits as well as evolution of the customer experience. We're quite pleased with both, and we're going to be ramping up our investments on that. That's also actually impacting, a little bit, the Q4 results is that we're increasing our investment in auto. Don't expect it to be a significant contributor next year, but we do believe it's important going forward. We are seeing both great consumer response and strong results to the credit. So we do plan to increase our investment there.

The next question will come from Kerry Rice of Needham & Company.

This is Jin Qian for Kerry. I have a question on the securitization. I think you -- previous quarter, you indicated a $10 million to $15 million revenue contribution expected for this year. I'm wondering if you have an update on that. And also compared to last quarter, how does the kind of unbalanced contribution of $98 million this quarter kind of impact on the revenue side? And as you expand your own contribution in Q4, what kind of an impact are we going to expect?

So on my prepared remarks, I indicated that we're still on track to be around that $15 million of revenue. What we've been -- through the third quarter, we've probably recognized a little over $6 million between the second quarter and third quarter. And then we've evolved from that. If you remember the first [indiscernible] any assets in the second. We always put $98 million in. In the third -- in the fourth quarter, we will start to increase that amount. That's why I was mentioning earlier that size of that transaction has not been finalized. But it'll probably be in the couple of hundred, $300 million-type ranges. We expect to recognize as much as $7 million to $9 million, call it, in the quarter. So you'll start to see that by contributing assets, the percentage of revenue picks up quite significantly. And again, as Scott mentioned, what we're finding is investors want to buy these loans in any structures, have them raised, get a CUSIP, and we're working with a number of large investors to satisfy their needs. So we're quite encouraged. We don't expect it to be more than in the circa 15% type of range of volumes, but it is an important part of expanding our investor base. As Scott mentioned, 30 to date that have not participated in any of our programs previously. Now doing the work, doing underwriting and putting money to work in various forms.

The next question will come from Michael Tarkan with Compass Point.

On credit again, I appreciate that sort of dynamic nature of the model, but I guess my question is that, if credit isn't holding up well in the lower end of the spectrum in this kind of environment, how do you feel confident that the underwriting process for near-prime and prime loans will hold dock if we get through a weaker credit cycle and really sort of using recent data? And I understand that it's sort of more current, but I'm just worried what happens when the overall environment starts to worsen a little bit more.

Let me touch on it, and then Scott maybe has his view as well. I think the first thing to keep in mind is that the access to credit for prime borrowers continues to expand. I think that as you see more and more players provide options for consumers, those consumers that are on the edge that are -- have lots of options, they are seeing more and more presented alternatives. And so they're taking advantage of that and, in certain cases, increasing their debt loads to level that is challenging. So what you're seeing us do is pull back a little bit. We're going to test those F and G type of credit categories to potentially underwrite them in a different way with some different features to see if we can improve the performance of those loans. It's important to keep in mind that, as we talk to you, keep in mind that every loan we originate is sold, that we are also very, very transparent and very disciplined about making sure we've got, obviously, investor returns to investors. And so it's important for everyone to understand that we need to take these actions and provide, again, risk-adjusted returns for our investors. So we think this is prudent, but that part of the credit spectrum is seeing some weakness.

Okay. And then as a follow-up, I mean, is there some risk of adverse selection that sort of pushes you up, the funnel? I mean, we're seeing more of a traditional spread baseline. There's -- coming to the market and focus on prime and super prime? I mean, is there some risk from a competitive standpoint that things are going to get a little bit tougher from that perspective?

I think that's what we're trying to address, specifically, that we don't have that kind of adverse selection. That's exactly what our efforts are trying to do.

Yes. I'll just add a couple of things. One is we believe we've got some unique product features that we're looking at that will differentiate our ability to assess credit. I pointed to the study by the Federal Reserve that, I think, at least gave some kind of a high-level view into the fact that we are doing that today. We believe the new model will help us do that more. But it's something that we're excited to put into market, give ourselves a -- what we think is a differentiated set of offerings to effectively compete in the market of today.

Okay. And then last one, just on the cash level. And I know it went down. I know you're doing more securitization, but how should think about that move or that pushing through to the end of the year? Like, how should we think about cash level moving forward?

I think, as I mentioned in my prepared remarks, we want to continue to maintain high levels of liquidity. That's first and foremost. The cash balance that you see moved down is just being redeployed into loans available for sale, which is part of the securitization that we had. So $187 million of loans are sitting in available for sale that is utilizing that cash.

The next question will be from Henry Coffey of Wedbush.

I'm trying to understand what you're doing with your credit models. But basically, the message seems to be that you're tightening credit, that you're shrinking the box that you sort of let in to the platform. Is that the right way to think about where this is headed?

I think there's two pieces going on here, Henry. The first, I think that we indicated that we do believe that, in the short-term, this is a tightening by reducing the amount of loans available for F and G partner -- borrowers, specifically, more generally. As Scott indicated, as we recalibrate some of our targeted models, we need to make some adjustments for those. So once we feel like we're getting those in place, we think we can start to provide credit to borrowers in a more refined way and with better execution. So I think in near term, it's feel like a tightening, but it's really is a combination of both.

So if we think about it in simplistic terms, you essentially have a prime product and a near-prime product, which I know was an oversimplification. And the F and G, I assume, is that the near-prime product? Everything else in prime?

Yes. The F and G is the bottom end of the prime. So if you just look at our grading system, H or G, A, B and C represents about 80% of our value. If you look at just the trajectory, you'll see, we're increasing the volume we're doing in the upper end of the spectrum, and we're decreasing the volume we're doing at the low end of that same spectrum.

And I'm trying to figure out why. If you can adequately price a near-prime loan at whether it has to be 36% rate or however it needs to be priced, why not just keep making them? What is the limit? Is the limit your pricing? Or is that the performance of the credit relative to expirations? Or...

It's a couple things. Keep in mind that one of them is that these credits have to meet a risk-adjusted return. One of the things we did see in those, and I mentioned in my comments, that these customers are being marketed pretty aggressively, and we are seeing a slightly elevated level of prepayments, for example, which have pretty -- have impacts in yields. And so that's one of the other reasons that we're looking at, trying to find ways to reduce that impact on the yield for investors. So it's not just credit. It's really both. It's the yield that we need to deliver to the investor, not just -- just not the credit loss.

And some kinds of risk, you can't price for, which is why we think there's product structures and other data sets we can use to really better assess the risk in that lower end of prime and use that to go after the borrowers.

One of the things that we have included, you'll get it tomorrow in the 10-Q, is the new chart that we've put in place for you, which breaks out the A through G volumes. And you'll start to see that we have been deemphasizing those categories really all year. So this is something that is a trend that you'll see in that chart. And that will be helpful for you, and so that will kind of lay it out for you.

But this is the volume-based business. As you tighten credit, your addressable market, whatever you want to call that, is shrinking through this process or holding about the same?

Keep in mind that F and G is, again, our 3% of our total volume, and our application volume in the quarter was up over 50%. So borrower demand overall is very, very high.

Yes. So just to give you some context to connect some dots here, I mentioned earlier, it's about a 5% tightening. The truth of it is in the F and G. So just to give you an order of magnitude. So on $2.4 billion, that's a pretty small percentage.

The next question will come from Mark May of Citi.

I have two, and I apologize if they've been addressed. One, do you -- I think you mentioned 58% year-on-year growth in applications in the quarter. Can you kind of tell us how that compares with recent quarters? And kind of what the average conversion rate is in -- of those applications? And then on the loans that are -- I don't know how you look at this, but if the loans are outstanding or loans that originated in the quarter, what portion of those were to borrowers that had at least one loan with one being called in the past?

So on the first topic, that 58% growth is a record high, so application volume is accelerating. Putting that in perspective of origination volume, we were up about 24% year-on-year. So we are being choosier with the loans we book. We are more selective. And that reflects a lot of the comments that we talked about earlier. I don't have the detail on subsequent loans that are within the quarter.

Is that something that you look at? I assume that it's -- you -- it's much more profitable from a customer acquisition cost. I'm surprised that that's not a metric that you focus on as kind of the repeat rate.

Yes, absolutely. And we have released statistics in the past. I just don't have those on the top of my head. But yes, indeed, consumers are very happy with their experience with LendingClub, and so we do see a strong repeat over the course of years.

The next question will come from Rob Wildhack of Autonomous Research.

I know you've talked a lot about the tightening here, but it sounds like you guys expect this to be a short-term thing. And if I'm understanding that correctly, it's temporary until the models kind of seasoned and allow you to bring some of these lower end of prime borrowers back of the mix. Is that the right way to think about it?

That's exactly right.

So my question on that then because I'm struggling to understand how that works if the borrower hasn't really changed. Maybe said another way, if a new model is improving the same borrower, how does that improve what the borrower ultimately does?

New model. So one, the model won't be approving the same borrower, right? There'll be people that we'll be excluding. But the big piece is, when we talk about how to assess these borrowers, it's -- I'm a little hamstrung in terms of what's out there in the market. We're using joint app only as a visible example of something that's live, but that's an example of a place where there would be borrowers that we would have given a higher rate to and potentially decline if they are an individual applicant because we would be looking at their individual income but assessing them against their household set of debts. So by pulling in 2 sets of incomes and actually having roughly the same set of debts, you get a new view into the borrower, right? And so there's a bunch of people you would still leave out, but there's some people you can bring it and you can price appropriately. So there's other product features and data sets like that, that we can use to really get to those borrowers on the cusp, the edge of prime and find the good credit risk and price them appropriately.

Okay. And then how should we think about the tightening [indiscernible] talked about versus scaling expenses going forward? I imagine that the 15% to 20% adjusted EBITDA margin you're thinking about was considered with a certain assumption for originations and borrowers and growth. And so how does then your outlook impact that margin and your ability to scale here?

Yes. Thanks, Rob. Let me take that. So we still think that our near-term goal is to get to 15% to 20%. Obviously, with this new guide, we're slightly below that. But we're in striking distance. We're making progress. I think the big observation I want everyone to walk away with this that as we do start to get over that $2 billion of origination volume, you start to see the margin expansion pretty quickly. And so obviously, we're pulling back a little bit here, but as we see ourselves continue to grow in 2018, we see our ability to continue to expand that margin, getting leverage on G&A, getting leverage on tech and being efficient on M&S. One thing that we haven't talked about, I want to also make sure, it kind of didn't come up earlier, but I want to highlight is, we are accelerating our efforts in auto as well. And that is we are starting see some traction there in our funnels and our marketing efforts there. And that is going to start to become more of a part of our investment. So we'll call those out separately so you understand the core business. But underlying this core is probably a pretty good benchmark on the core profitability in that $2.4 billion of originations. And as we step that up, you can see the margin expansion move pretty quickly. And then we'll continue to make investments in testing, in auto and other things like that as we manage ourselves for growth going forward. And ladies and gentlemen, this will conclude our question-and-answer session, and we'll also conclude the LendingClub's Third Quarter 2017 Earnings Conference Call. We thank you for attending today's presentation, and you now may disconnect your lines.