LendingClub Corporation (LC) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the LendingClub’s Second Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. And with that, I’d like to turn the conference over to Artem Nalivayko, Head of Investor Relations. Please go ahead.

Thank you, and good afternoon. Welcome to LendingClub’s second quarter of 2018 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 conference call is being broadcast on the internet. We have provided a slide presentation to accompany our commentary and both the presentation and 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 third quarter and full-year 2018. Our 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 earnings press release, 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 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 exclude stock-based compensation, depreciation, impairment and amortization and expenses related to legacy, and regulatory matters. Adjusted EBITDA also excludes these items and the related tax impact. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release and related slide presentation. And now, I’d like to turn the call over to Scott.

All right. Thanks, Artem, hello everyone. As you can see, we had a great quarter, record revenue on the back of record originations and with the success of some of our early cost management initiatives we’re starting to see flow through to the bottom line. So, I’m happy to say that our core business is firing on all cylinders and we are executing well against the strategy that we shared in our Investor Day back in December. We were able to achieve these results, because we were addressing a very real and growing need. Today, the U.S. consumer is holding a record high of more than $1 trillion in revolving credit card debt. Due to efforts like ours, more and more Americans are realizing that there is a better alternative. As reported by TransUnion last month, unsecured personal loans are now the fastest-growing consumer loan category in the U.S. And as the number one provider of unsecured personal loans, we are uniquely positioned to serve this growing demand. What started as a niche product is becoming mainstream enabled by a technology and data driven experience that delivers fast and simple access to credit at a lower fixed rate than credit cards. As discussed at Investor Day, we drive growth by focusing on three main areas; demand generation, throughput, and lifecycle optimization. On demand generation LendingClub’s machine is working. We drove nearly 50% increase in applications year-over-year. The growth is driven partly by the increasing awareness in appeal of our core product, the personal loan, and it is also driven by our relentless optimization of existing marketing channels and successful tests pushing into new ones. Once customers arrive at the front door, we drive throughput, gain new product capabilities, the use of alternative data to assess credit worthiness and process improvements to make the customer experience seamless. Features like Direct Payoff and joint application now represent more than a quarter of our business, and enable us to deliver more savings to borrowers while managing risks for our investors. Through automation and process improvements, we’ve cut the median time to get a loan by 40% over the last year. And our throughput efforts are showing not only in the financials, but also in the feedback we get from customers, including our recent recognition by LendingTree, based on customer reviews as the number one provider of personal loans on their platform. So, we’ve had great success with demand generation and throughput, and now we’re putting our focus on customer life cycle optimization. It would be easy to think that LendingClub has a transactional one-and-done relationship with our customers, but our data tells a very different story. Consumers are using personal loans as part of their ongoing money management strategy. And since our inception, about a quarter of our more than two million members have come back to us at least once for another loan. And according to our research, about 80% of them come back to us directly. And this repeat behavior is just based on their satisfaction with their first loan experience and not on having a truly differentiated repeat borrower experience. As you can imagine, we have knowledge of our customer’s financial health and an established a successful relationship, so we can and will significantly evolve their repeat experience to more seamlessly underwrite and serve them better. This optimized experience will form a competitive advantage for LendingClub. Further out, as we drive ongoing engagement, we will be looking to offer additional products and services that can provide more value for our members and help them generate more savings. Some products and services we’ll build ourselves, and others we’ll curate through a careful selection of like-minded partners. This is a win-win, where we can offer members personalized savings, while generating additional revenue at no-to-low acquisition costs. As we focus on driving more membership value, we’ll continue to evaluate and make strategic decisions about our existing portfolio. For example, one small part of our business that we have not spent time talking to you about is our patient finance and education unit, which we acquired in 2014. Today, we announced that, as part of our annual review, we took a non-cash goodwill impairment for this business. This is a great asset, but it does not benefit from our investments and the direct-to-consumer model, and we acquired it at a time when both valuations and growth expectations were different. As a result, we are evaluating multiple strategies for the business and for B2B2C as a channel. Switching gears to talk about the investor side of our business. We continue to execute well against our strategy of reaching low-cost scalable capital to support our growth, match our current credit profile and offer the best prices to borrowers. This quarter, we completed another successful securitization and saw strong demand for our CLUB Certificates program. Since we launched CLUB Certificates back in December, we have attracted more than $0.5 billion in capital from some of the top names in asset management, and we’re continuing to strengthen and grow our relationships with these new institutional partners. In terms of reaching individual investors, managed account, such as the 40 Act funds, continue to have appeal, because they can deliver liquidity and attractive returns through their use of leverage. Providing access to individual investors remains an important part of our strategy and we’re actively exploring new structures, such as the exchange-traded partnership that could deliver enhanced liquidity and returns versus our existing notes program. We’ve made good progress on structure in terms, and are discussing the ETP with potential investors and evaluating costs. If we choose to go forward with this program, it would likely be in 2019. Turning to credit. We’ve got a balanced view here, starting with the macro environments, where economic growth remains steady, unemployment is continuing at historic lows, and debt service levels remained below their peaks. On the other side, household debt levels are rising and the Federal Reserve raised rates again in June, with two more expected this year. So the cost of credit for consumers will continue to go up. For LendingClub, our portfolio is performing in line with expectations overall, and we will continue to diligently monitor and adjust as necessary. On balance, we have been tightening in a few areas to deliver returns in line with investor expectations. And in Q2, we optimized pricing in some segments and have raised pricing overall to reflect the broader rising rate environment. To lead our credit strategy efforts, we’re excited to announce that we’ve hired Ronnie Momen as our Chief Lending Officer. He comes to us after a long career, focused on unsecured consumer that has included very senior roles at Wells Fargo, HSBC and GreenSky. In managing our credit strategy, he’ll bring together our use of alternative data, pricing and product innovation to extend LendingClub’s lead. So, in closing out my comments on our operations, our focused efforts on demand generation, throughput and life cycle management are paying off and we are seeing the results of our increasing focus on expenses. So, we’re pleased with how we ended the quarter and are on track with our plan in 2018. One of our goals this year was to get the legacy issues stemming from the events of 2016 behind us and we’re making good progress. As you know, exact timing on these items is difficult to predict, but we do expect that most of the outstanding investigations and lawsuits from the legacy issues will be closed out this year, and we’ll be sure to provide any relevant news as soon as it’s available. In other news, on the regulatory front, last week, the treasury and the OCC released reports on the state of fintech and a roadmap for our bank charter respectively. We see both as positive developments and, as a recognition by the government, of how new models like ours can benefit consumers and how the regulatory framework can adapt to embrace them. Before I hand it over to Tom, I’d like to leave you with a few thoughts. Our core business is growing in line with the expectations we laid out for you at our Investor Day, we are competing well and we’re being deliberate in our investments to balance growth with profitability. Over time, you’ll see us make more foundational changes to our business operations to deliver long-term revenue growth of 15% to 20% and EBITDA margins of 20% by 2020, while serving our growing community of loyal members with more products and services. So with that, over to you, Tom, to provide more details on Q2 and on our outlook for Q3 and the full year.

Thanks, Scott. We had another record revenue quarter, driven by strong demand generation and our conversion efforts, and we’re pleased to see some of our early expense management issues bear fruit this quarter as we continue to leverage our scale. And we are very encouraged by our first half finance performance and we’re reconfirming our outlook for the second half of the year. In the second quarter, revenue was $177 million, up 27% from a year ago, compared to operating expense growth of only 12%. Our contribution margin came in at 48.3%, a 1% – excuse me, a one-point improvement year-over-year, and once again, towards the high-end of our 45% to 50% targeted range. And our adjusted EBITDA was $25.7 million, well above our guide, driven in part by favorability in our investor revenue in the quarter. All this contributed to over 11-point improvement in our margin year-over-year, coming in at 14.5%. Now, let’s walk through the 2Q operating results in some more detail. Transaction fee revenue was $136 million, up 27% year-over-year and LC’s highest originations ever at $2.8 billion, up 31% year-over-year. Transaction fees as a percent of originations were 4.82% in the second quarter, in line with the first quarter reflecting our origination mix shift into higher percentages of A and B grade loans. Investor revenue for the quarter benefited from several transactions. First, we executed at $330 million prime securitization. Second, we’re seeing continued growth in club certificates selling almost $200 million in the quarter. And finally, second quarter results benefited by approximately $3 million from the sale of the residual from our fourth quarter prime securitization. For more context on our investor revenue, I’d ask you to turn to page 16 of our earnings presentation, where we break out the economics of our structured program. Just to remind everyone, these include revenue from securitizations, sale of CLUB Certificates, interest income on loans held for sale and loans retained for risk retention. Offsetting the revenue, are related program costs, financing costs as well as fair value marks reflecting the amortization of loans, adjustment to credit losses, assumptions and any pricing discounts to meet investor yield requirements. You’ll see net structured program revenue was $5.6 in the quarter compared to $2.7 million in 1Q. The driver of the difference is the $3 million from the sale of the fourth quarter residual I mentioned earlier. As I said in the past, the structured program is a relatively new revenue stream in our business and does not cause – and does cause some variability in certain revenue line items. However, our structured program activities are an important part in that it allow us to facilitate more loans and fund our growth by tapping into new investor base. One of the other things I would like to highlight for you is how the structured program impacts our balance sheet. If you turn to Page 10 of our earnings release, we have added a balance sheet for your reference. There are two things I’d like to highlight: first, with the sale on the residual, I just mentioned, we’ve deconsolidated the loans held for investment by the company and brought that line item down to $9.6 million; and second, you will see the growth in the balance sheet of loans held for sale by the company at $515 million. These are the loans that we hold to facilitate our structured programs, the majority of which are already earmarked for specific transactions in early Q3. I’m encouraged by the capital market’s muscle we have developed over the last year, enabling us to use our strong capital position to support our growth. Now let’s jump back to our total revenue yield. Transaction fees were $136 million, up 22% sequentially, and in line with the origination growth of 22%. The remaining non-transaction fee-related revenue was $41 million, up 1% sequentially, and added 146 basis points to our revenue yield for the quarter. Total revenue yield debt was down 30 basis points from 1Q due to 1Q’s revenue mix as transaction fee growth outpaced growth in non-traditional – non-transaction-fee revenues. Now, let’s turn to the expense side of the equation, where our focus on leveraging our scale resulted in adjusted EBITDA margin of 14.5%, up over 11 points, reflecting revenue growth of 27%, set against lower operating expense growth of 12% year-over-year. M&S and O&S efficiency both improved in the quarter, driving a contribution margin of 48.3%. Sales and marketing expense was $67 million or 2.38% of originations, improving three basis points sequentially and 12 basis points year-over-year. The consistency and marketing efficiency over the last several quarters has been driven by the effective calibration of our marketing channel mix as well a strong performance in our partner channel. And As Scott mentioned, our marketing efforts drove 49% application growth year-over-year. We’re also taking advantage of the tailwinds and our strong execution and we’ll be testing it to match marketing in the second half of this year. While this will put some pressure on acquisition costs, we are encouraged that our personal loan products are becoming more mainstream that make sense for us to do some testing in our seasonally stronger quarters. Origination and servicing costs were $24.5 million in the second quarter, up $2.9 million sequentially or up 14%. While our cost went up, so did our efficiency as a percent of originations. The efficiency at O&S benefited from higher-than-expected volumes in the quarter. We are making incremental investments in this area to better support our growth and our customers, so I don’t expect to continue to see this level of benefit in the short-term. We’re also continuing to make good progress in the agreement to augment some of our operation staff with a third-party operating at a lower-cost location. While still early days, we’re seeing quality scores in line with our standards, our expanding our hours of operations and it’s all coming at a lower cost. We like the flexibility this partnership provides us to support the growth in our business. We are now scaling investment in this area to further support us and expect to see meaningful cost benefits in 2019. Engineering/operating expenses were $22 million in the second quarter, down $300,000 sequentially, and up $500,000 year-over-year. We continue to make good progress on the implementation of the new third-party servicing platform, and we’re on track for migration to begin in the first half of 2019. Turning to G&A. Expenses were $37.8 million for the quarter, or 21.3% of revenue, down three points sequentially. Thinking back on our commitment at Investor Day to focus on driving operational leverage and our fixed cost, the second quarter’s a good view into what we can achieve. Even when normalizing for last year’s insurance reimbursement and legacy expenses, tech and G&A expenses were up only 7%, with revenues up 27%. We are starting to drive a wedge to expand our operating margin in our business. We believe there are additional opportunities to pursue and have retained an adviser to do a rigorous review of our expense structure to position us for the next wave of growth. We have vast scale in our business and are optimistic that we can continue to drive operating leverage as we head into 2019. That said, we do believe that there will be some short-term costs associated with some of our reimbursement [ph] issues in the second half of the year. And you can see the results in our efforts to flow through to our adjusted EBITDA. For the quarter, adjusted EBITDA was $25.7 million with margin at 14.5 and improvement of 4.4 points sequentially, an 11.3 points increase year-over-year. Now let’s turn to our GAAP results. GAAP net loss for the quarter was $60.8 million. We have several adjustments impacting our reported results, so I want to walk you through some of these items. First, removing the legacy items in the non-cash goodwill impairment, our GAAP net loss would’ve been $6.7 million and ahead of our guidance from last year’s earnings call – last quarter’s earnings call. And the adjustments for stock-based compensation and depreciation and amortization were in line with our expectations. Second, for the quarter, costs associated with our legacy issues were $18.5 million, which reflects the latest discussion with the SEC, DOJ and FTC as well as our ongoing legacy litigation and indemnification of legal costs of the previous management. Some of these items are further along than others, but we are working hard to get most of these behind us in 2018. Also impacting the quarter was a non-cash goodwill impairment of $35.6 million of our patient education and finance unit. The impairment is an outcome of our annual review and reflects the focus on our growing our direct-to-consumer marketplace and our decision to evaluate multiple strategies for this business. With that, let’s turn to our outlook. First, let me start by commenting on the business environment. We expect the business environment in 3Q to be similar to 2Q, with strong borrower demand set against rising rates. I expect most of our revenue variability to come on the investor side, more specifically, there are a few items I want to call out that will impact our guidance: first, the sale of our 4Q residual will not recur, and that will impact revenue and EBITDA by $3 million compared to our 2Q reported results. Second, we expect interest rates to continue to rise that may result in initial revenue volatility in the investor area. We do expect to execute several more securitizations by year-end, and the timing and final pricing of these transactions may impact our quarterly earnings split. Third, on the expense side, as I mentioned earlier, we benefited from higher-than-expected volumes in O&S efficiency, and we plan to make incremental investments in our origination and servicing capabilities to ensure that we continue to deliver a best-in-class experience for our borrowers. And finally, we may incur certain costs associated with accelerating some of our expense initiatives in the second half of the year. With that in mind, for the third quarter, we forecast revenue between $175 million and $185 million and adjusted EBITDA of $18 million to $23 million. We expect stock-based compensation, depreciation and amortization will be about $33 million, resulting in GAAP net loss between $10 million and $15 million. Please remember that our GAAP guidance does not reflect the impact of any legacy issues for the quarter. Overall, we reconfirm our outlook for the year. For 2018, we expect revenue of $680 million to $705 million, and adjusted EBITDA of $75 million to $90 million. Consistent with what we shared with you before, our GAAP net income guidance does not reflect forecasted costs related to legacy issues. However, our current outlook for GAAP net income is being updated for our year-to-date actual results, and our full year GAAP net loss guidance is now estimated to be between $124 million and $109 million loss. We do not expect any significant changes in our outlook on stock-based compensation, depreciation and amortization, which we’re estimating to be about $128 million. With that, I would like to turn it over to Q&A to answer any questions you may have.

[Operator Instructions]. And the first question today comes from Brad Berning with Craig-Hallum. Please go ahead.

Good afternoon guys. Congrats on the execution. One more strategic question, as you guys strive to diversify the product platform a little bit, maybe you can expand upon areas of interest there? Obviously, you’ve made some hires in different directions, and I think investors are looking for some thoughts in that direction? Second, more of a household cleaning item on the quarter, just can you walk through some of the fair value adjustment items that were securitizations versus non-securitization-related items, and how will those move going forward now that you’ve sold the residuals? And then the non-securitization piece of that, how does interest rates impact loans held on the balance sheet for those items, if you can just walk through some of the moving parts of that revenue line item, I’d appreciate it.

Sure. Thanks, Brad. A couple of things to talk through. First, I want to mention that, for the quarter, most of the mark-to-market that we discussed have already come through that structured program, and you’re seeing that offset with interest income and the gain on sale from the sale of residual. So the big driver for the quarter was that $3 million. The way that we’re looking at securitizations between now and the end of the year as we continue to see continued growth in CLUB certs as well, CLUB Certificates, and so we’re constantly balancing the need to accumulate loans to deliver into a CLUB Certificate format or pull them for a larger securitization that we’ve done in bulk. What happens as a result of those two things, we may retain as we build loans to deliver into securitization, may stay on the balance sheet longer, and then you’ll see higher levels of interest income and then also corresponding marked-to-markets on that corresponding loans. Those typically offset because the loans amortized quite quickly since the short duration. And we’ve been able to see that pretty much for the first half of the year with that phenomenon continues. As far as our outlook for the year, we’re continuing to see a rising rate environment. We don’t take a lot of risk on the balance sheet for that. Obviously, we do have – our objective is to manage demand on the investor side where yields are versus the rates we’re charging borrowers. As you’ve heard Scott mentioned, we did increase rates to borrowers in the June timeframe. That’s the second time we’ve raised rates for them, and we’ll continue to evaluate the pace and level of changes to borrower rates as we manage our way through what has been a rising rate environment, really, for the last year. Those are some of the things that we think about how we manage and think about going forward. My comments about the quarterly splits, doesn’t really subject to just the timing of securitizations. Right now, we are projected to do a prime securitization in 3Q, depending on the market, but that could slip to the fourth quarter, but it’s our intent to have that done in the third quarter, and that may impact some of the quarterly splits, but we just want to highlight some of the moving pieces that we have in the revenue line. Scott, you want to mention some of the strategic focus?

Yes. So Brad, without painting too much of a detailed picture further out, I think what I want you to understand here is that our investments on the product side are really going to be focused on areas where we know we’ve got a real interest from our customer base and can drive pretty immediate value. So I talked a little earlier about the fact that we have people coming back to us, how do we make that seamless and easier through product innovation there? We’ve talked about the wins and things like direct payoffs. That’s still only exposed to a minority of our customer base, so there’s lots to work there to broaden the appeal of that. You take something like auto. We’re making great progress in that business, the savings that we’re generating for customers there is really fantastic. So on average, we’re saving people more than $80 a month off their payment. We’re going to look at taking those capabilities to secure a title and use that to say yes to more people who are coming with us today for a personal loan that were either not able to approve or we need to charge them a price at the very upper end of our range. So those are the kinds of things that we’re focused on right now that you’ll be seeing over the coming quarters. And when I talk about things like partnering with others to enhance the savings we can have. So just an example of that would be with auto, the information I need in order to assess your – our ability to save you money on your auto is effectively the same thing I need to assess if I can save you money on your insurance. So it would be logical, while I have you at that time to see that if I can save you more than your $80 off the car payment, off the savings the money off the insurance payment. That is being example of the kind of thing you can expect to see us exploring over the coming quarters.

Thank you very much.

Next question comes from John Coffey with Susquehanna. Please go ahead.

Thanks. Hi, Tom. I was wondering if you could expand a little bit on the nature of the second half costs you spoke of?

Yes. So, we have – first of all, we’re really encouraged by what we’ve done in the first half, and we’ve got quite a bit of momentum in the areas I highlighted. We are kicking off of a new program to evaluate all of our cost and understand how we may leverage or scale even more than we’ve already done to date. The comment I was mentioning was where that there are clearly some things we benefited. So, we got to break it down again. First, in our operational area, we had a very, very strong growth in volumes. And so we clearly got a little bit of benefit in our O&S area, so that was one area that I wanted to call out, specifically operationally. The second thing though is that some cost initiatives do cost money, and so the timing of those sometimes are not aligned, where we may have some costs that need that need to be front-end loaded to get those savings. But we’re encouraged by, like I said, the early progress we’ve made, and then – but we don’t want to hesitate and wait to do these things. We want to move as quickly as we can and get the savings as fast as we can in 2019. So, that was I was calling out with regard to some of those expense items.

Okay. Thank you.

Next question comes from James Faucette with Morgan Stanley.

Great. Thank you. I just wanted to get [indiscernible].

I’m sorry, James. There was a lot of static and feedback, if you could please call back. Our next question comes from Mark May with Citi. Please go ahead. Mark May with Citi. Perhaps, you’re phone is muted.

Hello. Okay. Thanks. Sorry about that. In terms of the mass market advertising, just trying to get a sense of the scope of how much larger in the second half of this year you’re going to be than, say, this time last year and kind of why you’re deciding to do this at this point? And maybe how this particular test may differ from previous mass market tests? And then in terms of exiting the patient finance and education offerings, can you maybe talk about the auto lending test, I believe, that you’ve been running and how you’re thinking about that going forward? Thanks.

So, on the marketing side, broadly speaking, we’re always optimizing our channel mix. We are always pushing in to new channels. And as Tom indicated, if you look at the efficiency, we’ve been able to drive while still driving this top-line growth, that’s because we are both performing better in existing channels through things like creative optimization and response model optimization, but I’ll speak as we’re pushing into new channels. We – and as you look to channels outside the more targeted ones and go broader, what we’re seeing is we are experimenting in a number of new places and have been over the past several quarters, and we’re seeing positive indications there. And that, combined with what we see right now, is overall tailwind on consumer awareness, leads us to say, "let’s test a little bit in some of the really broad channels and see what kind of response we get. And why now?” It’s because Q2, Q3 are really our best channels for overall consumer response. So getting a read now that we can kind of take our learnings and come back at it, potentially next year, is the reason we would do it now. In the scheme of our overall budget, it’s not very significant. But as with any new thing you try, it’s certainly not going to perform at the level of marketing mechanics that we have been at for the past 10 years. And then switching gears to the patient finance business. Just to be clear, what we said we’re doing is really evaluating that business and really assessing the level of investment required there, where can our capital be best deployed to drive the most value for our shareholders and this non-cash write-down essentially gives us the flexibility to make the right decision for shareholders that we’ll be evaluating. And I think you have another question in there on auto and let’s say that the update there is we are continuing to work on that overall experience. We are making very good progress on driving throughput which is really our focus. We’re not at the top of the funnel right now. We’re trying to make this process easy because it is more complex, the process of perfecting a title. One of our – one of the key things will be doing with those capabilities as we perfect them as they directly apply to the ability to potentially secure a personal loan so that will be something that we’ll be working on to bring to the market over the coming quarters.

Thanks.

Next question comes from Michael Tarkan from Compass Point. Please go ahead.

Thanks for taking my questions. Just quick one on the marketing expenses on the back half of the year, again. So I know you guys want to test new things, but with the growth that you have this quarter and the momentum, it just seems like, why spend more in the back half? It seems like things are working well. Is it related to just more competitors and more just competition stepping up?

Yes. I’ll give you my view. I think that we are testing constantly. A lot of things you probably don’t see so new program, new partners, and new creatives and a lot of things that the market can see. We know you’ll see this and we wanted you to understand the context behind it but it is a full test that we are evaluating. So in the grand scheme of things, this quarter, we spent probably $69 million, $67 million in sales and marketing expenses, and we do not expect this to be very big. But we do want to – we do expect you guys to see some of it and we want to have that context for you.

And just overall on competition, because it’s certainly a question we’ve been getting from this community. I think we’ve pretty consistently indicated that we feel good about our ability to compete here given our track record and scale and data and strategic road map that we’re executing against. You’re seeing that. We are benefiting from overall strong execution and growth of this customer base and we are maintaining our position here. So we continue to feel good about that. As some of you know, there is seasonality in marketing expenses, so certainly Q4 and Q1, generally, are a tougher hill to climb than Q2 and Q3, and that’s why we tend to do more testing in Q2 and Q3, it’s because we’ve got a little more room and the consumers are more responsive.

Okay. Thank you for that. Just back on the fair value market this quarter, can you just unpack that a little bit in terms of whether that was rate related, credit revisions, just maybe a little bit more color there.

So what I was saying here, I want to make sure that you guys understand, that the fair value market needs to be looked in the context of interest income and that’s because of the type of products we have. So let me just make sure we are grounded on that. When we originate a low and hold it for, for example, securitization, we will earn the interest income while we hold it, but there’s a lot of things going on. It’s a short duration product so you start seeing early stays defaults, you may have just a paydown of a principal. And so the mark, if you will, is reflecting that passage of time. It also may include changes in outlook on credit. It may include changes on impact on interest rates as well. If I bring it to the Page 16 in our restructured program, you can see pretty clearly that the interest income offset by the interest expense and the fair value market pretty well offset each other, which is trying to capture that phenomenon. So that’s what I was trying to say is that they kind of aligned. Now keep in mind, to the extent that we use the balance sheet to facilitate some various structures, we’re obviously always trying to maximize the economics for us, but it is an opportunity to – for us to get into new investor bases and create new products. But the total fair value mark really reflects the items I just mentioned.

Okay. Thank you.

Next question comes from Heath Terry with Goldman Sachs. Please go ahead.

Great, thanks. I would love to be able to dig down just a bit in terms of the marketing efficiency that you saw this quarter. How much of that should we attribute to new channels that you’d experimented with? I know you mentioned some additional experiments in the fall, so channels shift versus the channels that you’ve been using, becoming more efficient, are you seeing sort of higher ROI either because of decreased competition or an incremental increase in consumer demand? Just trying to sort of better understand the improvement in profitability and the faster origination growth.

I think – this is Tom. Let’s go back in time and look at this line, I’m sure you guys have been watching it, but from a year ago, we were running at about – M&S at about 2.5% in the second quarter of last year. That number was up in almost 2.7% in the first quarter. So you’ve seen this trend actually continue for quite some time. We talked about a little bit with our new credit model in the third quarter as we started to calibrate the model into the first quarter. So we’ve seen a pretty consistent trend coming down into that 2.4-type range over the last few quarters – we were talking – what we were talking about here is that we’re constantly evaluating changes in the mix, paid versus unpaid, DM versus unpaid channels, there’s a whole host of initiatives that we do. One other thing I wanted to call out is that, once you know that we’re constantly testing, given the volume that we do, the amount of test that we can do on a monthly basis is in the dozens, where we’re constantly testing new creatives, new approaches, new channels, new partnerships and so we’re constantly evaluating. What we called out today on the mass media is just to say, you’re going to see this, this is another test, I’d like to see what we can do to help augment some of their existing marketing efforts. So we’re not saying that were going to have a material shift in our M&S. As I said, we spend a good chunk of change here. We don’t expect this to be material, but it is going to be a little bit higher than maybe what we would have expected but we’re not talking materially.

Great. Thank you.

Next question comes from Rob Wildhack with Autonomous Research. Please go ahead.

Hi guys. Tom, I want to go back to the comment you made earlier on balancing CLUB certifications and securitizations, where is the demand shaking out right now?

So one of the things that we’re doing is that first, we’re really encouraged. When we started the CLUB Certificate, if you think about it, we only did our first one in December last year. We’ve already done about $360 million in the first half of this year. So we’re quite encouraged because we’re seeing the types of investors that are interested in this product open up a whole new investor opportunity. Those investors typically are not the ones that are coming in and buying A, B and C tranches, so it’s a different investor profile. And so we’re constantly balancing the desire to expand our investor base, while also maintaining good liquidity and the program of securitizations. So that is something that we’ll continue to balance, but we’re quite encouraged on the outlook for CLUB certs, and we think we need both of them. It’s not one or the other, it’s really both, because they touch and give access to this asset class to different investor groups.

Got it. And net of all the moving parts, is there an economic difference to LearningClub between the two? Is one more profitable than the other?

I would say they’re equally profitable. The difference is that the securitization tends to have to be larger in size, so we typically like to do securitization transactions somewhere in the circa $300 million, whereas we can do a CLUB cert at $25 million, $50 million chunks. So it’s really a question of how long it takes to accumulate the assets. Again, one of the things that we have differentiated capabilities, we can fund a CLUB cert order pretty quickly just given the volume that we have and so we can deliver that in a couple weeks, given the size that we have. We do get a lot of preorders on these search, so we know exactly how to fill them. And so it’s just a slightly different operational and capital deployment strategy.

Got it. Thanks.

Next question comes from James Faucette with Morgan Stanley. Please go ahead.

Hi, can you hear me better now?

Yes, it’s way better.

Okay. Great. Thank you. So my first question is, that in the prepared remarks, you touched on this, and I’m wondering if you could expand or give a little more color on kind of the mix and how that was impacting your take rate earlier in the year and how should we expect that to evolve through the rest of this year and going forward?

So, James, I’m going to start by trying to clarify two things: when you say mix, so you’re talking between our custom program and our prime program? And by take rate, are you driving borrower acceptance rate? Or are you talking that about revenue yield?

I’m talking – I’m sorry, revenue yield, and kind of how that factor maybe impacting that.

Okay. I’ll let Tom take that one.

Yes, so it’s not like I don’t clarify questions, James, it’s just that – are you talking. Are you talking about actual borrower rates themselves and how investor deals their…

Yes.

Yes. So I think that, as we’ve indicated, as interest rates have moved up, investor yield appetites have has also increased as they look at the asset classes, they would look at all asset classes. We have been moving rates up on the borrowers’ side, monitoring our take rates accordingly to make sure that we’re not getting adverse selection by moving rates too quickly on the borrowers’ side in order to meet the demand end of the yield of the investor side. So this has been a important strategic issue for the company that a lot of times, we get questions, how you’re going to get to manage in a changing interest rate environment. And you are seeing that. We are facilitating the balancing between those two competing demands and watching any potential adverse selection. We’ve been doing that really for the last year. So we are monitoring that closely across all of our distributions to make sure that we’re not getting that kind of adverse selection by moving rates too quickly. But that does sometimes, it does put pressure on our yield to investors and to the extent we have to modify our pricing, we do that accordingly.

James, just if you are trying to get a transaction fee yield, that’s pretty stable quarter-over-quarter. We saw a shift in Q1 as we move to a higher quality credit. Transaction fee yield dropped a bit, but it’s a stable Q1 to Q2.

Okay, great. I appreciate that. And then Scott, you mentioned in your prepared remarks, that some of the – or most of the examinations and the like, going back to 2016 events would be tied up and finished up by the end of this calendar year. Can you give a little more detail on as to which ones you’re referring to and kind of the things that we should be looking forward to make sure that those are progressing kind of a resolution on the timeframe you talked about?

Yes. I mean, obviously, the longest standing ones were the SEC and the DOJ, those have been out there really the longest amount of time, and we are encouraged by the conversations we’re having right now and expect that we’ll have those wrapped up in the coming quarters.

Okay. And then as far as the newest one, the FTC, is that also within that group that you think could be resolved by the end of this year? Or do think that may take longer?

Yes. I mean, it’s hard to really give an answer on that one definitively but as you’re probably aware, the next step there is to hearing or a motion to dismiss on September 13.

Okay, great. Thank you so much.

Next question comes from Eric Wasserstrom with UBS. Please go ahead.

Thanks very much. Two questions please. Can you guys hear me okay?

Yes.

Okay, great. Thanks. The first is, Scott, the origination figure this period was really astronomical. Can you give me a sense of what you think sort of the run rate origination opportunity is as you expand the marketing profile of those kinds of things relative to where we are right now?

This is Tom. I think it’s difficult to predict originations as we have not done that before. We are trying to manage our business within the footprint and the expectations we have with our expenses and so forth. We mentioned a little bit even the pretty significant increase we saw in the second quarter put a little pressure on our operations. So $2.8 billion, feel pretty good. Can that number continue to grow? We think the answer is yes. I think the opportunity for personal loans to continue to become a more mainstream product, it continues to be something that the trend continues. So do I see us continuing to grow our originations? The answer is yes, as far as projecting specifically, that’s going to be something that we’ll get a better read on as we head into 2019 guidance. But we have a good position and we’re seeing some very, very good things happening in our distribution channel. And as Scott mentioned, some of our existing customers coming back for additional products. So we’re quite encouraged, but I’m not going to put a specific number on what the originations could be.

And of the origination figure, how much relates to the clients using a new asset to refi out of the existing assets? So in other words, what was like the net new?

So the – it’s a couple of things that clarifying the question. Most of our originations are debt-consolidation products. And so we estimate that number to be somewhere in the 70% of the use cases. So obviously, that debt, one of our main marketing messages is that using a installment loan personal loan product is just a better way to manage your debt, and consumers start to realize and then go online and save significant percentage in interest as a result of that. So that’s the biggest use case that we have and one of the most compelling marketing messages we have.

Most certainly. I guess, I meant, Tom, like how much is our new LendingClub is replacing existing LendingClub [ph] loans?

Yes. We haven’t disclosed that specifically, but Scott did mentioned that we have experienced that 25% of our – over two million customers have to come back a second time. So we think there’s a big opportunity there to continue to serve customers after using this product as another vehicle to manage their credit profile, and we see that as a very large opportunity as we go forward to serve these customers throughout their use of credit.

And just one final one. In terms of the work that you’re doing on addressing your expense base, which is very admirable and critical. Can you give us a sense of sort of how you’re viewing your glide path to GAAP profitability in terms of time frame and sort of what you would consider an acceptable level of accounting profitability?

Yes, it’s still a big focus for ours, as we mention at our Investor Day. We think we want to let this into a couple of chunks, if you will. First, we want to show that we continue to show great growth on the top line. You’re seeing that $2.8 billion originations, maintaining our efficiency driving, good CM, feel really good about that. You also saw the efforts through 2 Q starting to really show the benefits of leveraging our fixed cost infrastructure and even on some of the variable costs not having them grow as fast. So those are all encouraging things and the old management team is focused on that. As that translates down to the bottom line, I think the next thing we’d like to start to do is show that we’re trying to shoot for that 15% type of EBITDA margin. We think that in the short run as the first hurdle for us to get through, we want to balance the amount of investments were doing, to make sure that we’re not pulling for profitability too quickly. There’s a lot of things we want to invest in, but we’re still trying to balance that. But we wanted to try and call out that now we’re going to go through a full review, we’re going to do a full assessment to really start to reevaluate how fast we can do that. So I would think that we get those types of issues teed up, and hope I could give you some more information when we give you the 2019 guide. And then just to connect back to what Scott said, we got to put the legacy issues behind us. So those are the ones that are really are impacting our GAAP-reported numbers. Let’s get some of these charges behind us, and I think we can start to have a discussion about getting to net income positive as we leverage our scale. So more to come on that one. It’s a focus area for us. It’s strategic to get ourselves to that level of reporting. Hopefully, this quarter, you saw a little glimpse of what we can do with our expense base and we’re encouraged to continue to push forward.

Excellent. Thanks very much.

Next question comes from Jed Kelly with Oppenheimer. Please go ahead.

Great. Thanks for taking my question. Just on some of the volume growth you saw this quarter, are you benefiting at all from sort of some of the credit card companies falling back on the 0% balance transfer offers? And then I missed some of the opening remarks, but have you seen any operational changes or any of your operations changed in any way in terms of investor demand or borrower demand from the FTC lawsuit?

Yes. So no, we don’t see the big driver here as being pulled back in credit card offers because I think the amount of mail sent, there’s also richness of the offers, and those two things are kind of going in slightly different directions right now. Our positioning vis-à-vis the cards have generally been get off – get out of the balance transfer game and the hamster wheel game because everyone knows that only last so long and then these things reset and then you reset at a rate that is higher. And just from an overall credit health perspective, you’re utilizing your available credit, it’s going to be pushing down on your overall FICO score. So we see the growth really coming from, like I said, both the overall, we think, increasing awareness by consumers of the benefits of the category, and then specifically a lot of our effort to optimize our marketing channels, optimize our creative, optimize our funnel pull-through user experience and all those pieces, and we can connect a lot of the benefit directly to those initiatives and that optimization. On FTC, I would say, on the borrowers’ side, we really haven’t seen an impact there as we’ve stated before, nobody likes to be in a fight in the regulator and that includes us, but we feel very strongly about our position here and it’s not news that it’s really kind of trickle down to the borrowers’ side of the community or customer reviews as evidenced by the LendingTree award I talked about in the prepared remarks, continue to be very, very high and very, very strong. On the investors’ side, our existing investors, and I would include our existing bank investors, have all reviewed extensively our disclosures and operations, and they are quite comfortable with our practices. Certainly, new investors, this is something that requires extra diligence and an extra level of comfort needs to be obtained. And so that’s understandable. It’s a reality, and that’s one of the reasons why we look forward to putting this behind us as soon as we reasonably can.

Thank you.

And the final question tonight will be from Brad Berning with Craig-Hallum. Please go ahead.

Hey one more follow- up on the health care business. Can you help size up that business either from origination our portfolio standpoint, and the contribution relative to the overall business, just to help investors understand what’s being evaluated a little bit more?

Yes. It’s single digits in terms of overall contributions. So it’s a small part of the overall business.

Single digits as far as percentage of the loans that are out there, or are you talking single digit millions contribution?

It’s both in terms of loans and margin contribution as a percentage.

Got it. That’s very helpful. Thank you.

And with that, that will conclude today’s question-and-answer session as well as the call. We want to thank you for attending today’s presentation. At this time, you may now disconnect.