LendingClub Corporation (LC) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to LendingClub's Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Sameer Gokhale, Head of Investor Relations. Please go ahead.

Thank you and good afternoon. Welcome to LendingClub's third quarter 2020 earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO; and Tom Casey, CFO. Our remarks today will include forward-looking statements that are based on our current expectations and forecasts and involve risks and uncertainties. These statements include, but are not limited to, the impact of COVID-19, our ability to navigate the current economic environment, the timing and benefits of our pending acquisition of Radius, platform volume and the future performance of our business and products. 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 press release and our most recent forms 10-K and 10-Q, each as filed with the SEC, as well as our subsequent filings made with the Securities and Exchange Commission, including our upcoming Form 10-Q. 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. A description of non-GAAP measures and reconciliation to GAAP measures are included in today's earnings press release and related slide presentation. The press release and accompanying presentation are available through the Investor Relations section of our website at ir.lendingclub.com. And now I'd like to turn the call over to Scott.

Thank you, Sameer, and thank you, everyone. We know it's a busy time right now, and appreciate you all joining us today to discuss our third quarter results. So let's get to it. In what continues to be an uncertain environment, we do feel good about our ability to control what we can control. We increased loan volume by roughly 80% quarter-on-quarter, that is in line with what we told you to expect back in August. And investor demand continues to build driven by the strong performance of the pre-COVID loans as well as encouraging early data on the post-COVID vintages. We are managing our business for success over the long run and we are remaining prudently conservative in the short term. We anticipate continued deliberate loan growth as we monitor the path of the virus and its impact on the economy, can see the size and form of any additional government stimulus package and observe the evolution of consumer behavior. All while we collect additional data on the performance of our post-COVID vintages and continue to test and learn on pricing and policies suited to this unique environment I'd note we are not sitting still and hoping for things to get better, rather we're actively strengthening our core capabilities and enhancing our adaptability. We are investing in our electronic trading platform, LCX which gives us the capability to seamlessly auction loans at above and below par prices without the use of our balance sheet and which is scaling nicely. We've developed a new price testing infrastructure and are implementing a revised go-to-market strategy that we believe will enhance our recovery. And we've taken steps to decrease our fixed operating costs, reduce our operating risks and increase our liquidity. So with the proactive actions we've taken to deliver strong investor returns, improve efficiency and build a substantial amount of liquidity, we are well positioned to navigate the current environment and complete the acquisition of Radius which remains our top strategic priority. So before I go into further updates, I'll spend a minute on the broader environment. Clearly conditions to date have been better than feared after the initial onset of COVID. GDP is rebounding, initial unemployment claims are dropping and consumer spending is recovering in many categories. As said, there are still things we don't know. Initial unemployment claims remain well above pre-pandemic levels. The virus continues to grip the country and the timing and size of an additional government stimulus package is unclear. The good news is that consumers came into this recession with strong balance sheet, and they do appear to be behaving prudently with increased savings rates and a focus on paying down their debts. We are therefore seeing encouraging stabilization of credit performance across consumer asset classes, which is great and we're closely monitoring to see how this performance holds as the effects of stimulus and payment moratoriums fade. Since the onset of the pandemic, we've organized our efforts around five guiding principles. And let me update you on where we stand on each of these. Our first priority is to keep our employees safe, engaged and working productively. I'm pleased to say that we remain safe with few reported cases of COVID, and Lending Clubbers remain engaged, productive and able to effectively operate our business and serve our customers. As a result, we are not asking employees to return to our offices until at least the summer of next year. Our next priority is to protect loan investor returns and we are encouraged by the data we're seeing. Our pre-COVID vintages which represent the bulk of our servicing portfolio are demonstrating enormous resilience. IRRs are getting close to our historical averages, coming in at roughly 4%, which is a 100 basis points higher than our most recent forecast. I'd highlight that the installment nature of our product and its short duration means that risk for loan investors is receding with every passing month. On new post-COVID issuance, we're seeing equally encouraging early data and currently expect the prime portfolio IRRs to be in the 5% to 6% range. This is well above our historical averages, and provides a good buffer against any potential future volatility. These strong results to date are driving investor confidence and are resulting in an increase in Q4 purchase orders as well as interest from new investors to come onto the platform. While we are pleased by what we're seeing, we are responsible stewards of credit and will continue to maintain a prudent approach with a relatively tight credit box as we get a few more months of data and closely monitor the broader environment. Our new issuance is primarily focused on existing members as these loans perform better and cost less to acquire the loans to first-time borrowers. I would remind everybody that we've been sharpening our focus on the existing member and existing member experience for some time and we've improved utilization. We have streamlined the experience. We've developed customized underwriting by leveraging the richer data available to us, and we see this loyal member base as a key competitive advantage, which will become even more valuable when we can offer additional products and services at the bank, which is why building and maintaining a strong member base is the next strategic priority, I'll touch on. One of the reasons LendingClub has such high net promoter scores and return rates is because our customers know that we're genuinely committed to helping them improve their financial well-being. Since the onset of the pandemic, we've helped more than 217,000 of our members with much needed forbearance relief. We've rolled out new payment plans, new payment options and new ways for them to reach us. And as you can see in the results, it worked. On to our fourth priority, preserving liquidity, where it's worth calling out that we increased net cash this quarter to $445 million while paying down our warehouse lines and paying off all of our revolving debt. We are now in a strong position to navigate the current environment and to acquire Radius Bank. After the acquisition, we will be a very different company. We will be the first public neobank and the only full spectrum fintech marketplace bank in the U.S. What does that mean? What's a marketplace bank? Put simply, we will maintain the benefits of our marketplace while retaining a portion of our installment loans on our balance sheet, finance with the low-cost deposits of Radius and delivered through our branchless infrastructure. The attractive economics generated by this combination will enable us to price competitively and deliver value to both depositors and borrowers. And perhaps most importantly, checking experience in accompanying mobile applications will give us a platform for ongoing member engagement that provides for an ever deeper understanding of our customer, so that we can identify additional opportunities for them to save, while driving a significant increase in the lifetime value of each relationship. In addition to these member benefits, there are significant strategic and financial benefits for LendingClub of the acquisition, including access to stable funding, wider margins and recurring revenue. So acquiring Radius will be a win for our members, our loan investors and our shareholders. In Slide 7 of the earnings presentation, we show the progress we've made as we work towards completing the acquisition. We filed our Y-3 application with the Federal Reserve on September 25, deployed cross-functional teams across both organizations and announced the first of our intended new deposit products. We are working hard to complete the acquisition within the timelines we laid out in February. So with that, I'm going to turn the call over to Tom for a detailed discussion of our financial results.

Thank you, Scott. Compared to the second quarter, our results primarily reflected the next step in our recovery efforts and the impact of significantly improving our liquidity profile. Specifically, loan originations grew 79% quarter-over-quarter as investors continue to see the resiliency of our loan performance. We also reduced loans held-for-sale by selling $410 million of loans off the balance sheet. In addition, we materially deleveraged the balance sheet by paying down a warehouse lines almost completely, and fully paying off our outstanding revolver while increasing our cash balance to $445 million. Furthermore, our results reflect the steps we took to successfully reduce our expense base and drive efficiency through our marketing efforts. For the third quarter, we reported GAAP loss of $0.38 per share compared to a loss of $0.87 per share in the second quarter of 2020. Excluding the impacts of non-recurring items, we reported an adjusted loss of $0.25 per share which compared to an adjusted loss of $0.60 per share in the second quarter. In Q3, loan originations increased to $584 million. We grew originations while maintaining tight underwriting criteria, increased pricing and focusing on marketing primarily to our existing member base. We are in the process of gradually reopening paid marketing channels as we maintain a prudently cautious approach to driving growth. As Scott mentioned earlier, our loans continued to perform well with IRRs on our pre-COVID vintages returning to historical levels of approximately 4%. Reflecting the resiliency of our personal loans as an asset class, the effectiveness of our strong underwriting, servicing and collection efforts, and likely some impact of the government stimulus programs. Early performance indications are that post-COVID vintages are on track to deliver IRRs of 5% to 6%, reflecting tighter underwriting and increased loan pricing. Our data indicates that borrower payment patterns continue to be in line with historical patterns and recent third-party research firms confirms that personal loan payments rank relatively high in the higher fee and consumer debt payments coming in just above credit cards and below auto loans. In Q3, our transaction fees increased $24 million from $4 million, approximately half of the increase reflects higher origination volumes in the quarter, with the rest due to the increase in prepayment assumptions to pre-COVID levels. The increase in Q3 originations is consistent with increased investor demand on our platform. During the quarter, our investors doubled their purchases from Q2 levels and confidence continues to build in Q4. Existing investors are increasing their orders, and we're seeing greater interest from new investors and loan pricing overall is higher. Net interest income and fair value adjustments decreased to $14 million from $16 million, reflecting a decrease in net interest income offset partly by an improvement in fair value adjustments. Net interest income decreased by $8 million as a result of loan sales and our decision to increase cash and to deleverage the balance sheet. In Q3, we did not see any significant marks on our loans. In fact, we sold $410 million of loans from the balance sheet, primarily originated pre-COVID at approximately their carrying values. Net interest income and fair value adjustments this quarter includes the benefit of $5 million, reflecting positive fair value marks on our loan and securities portfolios driven by improving loan performance. Investor fees increased to $26 million from $19 million, primarily reflecting return of prepayment assumptions to pre-COVID levels. Our results during the quarter also reflected a significant increase in our contribution margin to 71% from 49% in the prior quarter. Adjusted for asset sales and updated fair value impacts, the contribution margin would have been about 62%, this compared to our historical contribution margin of approximately 50%, highlights the benefits of marketing primarily to our existing members. Given the better credit performance and low marketing costs, a returning member who take the second personal loan has three times the lifetime value of first time customers who do not. With the cost efficiencies we gained by focusing on our existing members as well as our resized operating expense base, we believe that we can return to operating profitability and an origination volume of approximately $1.5 billion per quarter or roughly half that of our quarterly run rate in 2019. Now let's turn to some of our liquidity management actions we took this quarter. As we mentioned last quarter, we intend to sell assets and generate additional liquidity to purchase Radius and provide the bank with a strong and clean balance sheet. As you can see on Slide 8 of our earnings presentation, since the end of Q1, we reduced our balance sheet loan exposure from $940 million to $270 million, primarily as a result of sales through 2Q and 3Q, mostly at or above our carrying values from 1Q. During the third quarter, our cash and cash equivalents increased to $445 million from $338 million reflecting the loan sales as well as an increase in our operating cash flows. We also fully paid off our revolving credit facility of $70 million and paid down debt on our warehouse lines by $290 million, leaving only about $19 million outstanding at the end of the quarter, which was paid down in October. Our only remaining debt has been termed out, effectively eliminating all risk of capital calls from our balance sheet. As you can see on Page 15 of our earnings release, we have a strong balance sheet with $720 million of tangible equity, excluding loans and securities that are required to be consolidated but on which we have no risk exposure. Our tangible equity to asset ratio is almost 70% which is to giving you higher compared to most banks especially finance companies. Furthermore, this is not consider our deferred tax assets of $170 million against which we have a full valuation allowance. With our strong liquidity position and derisking the balance sheet, we are well positioned to complete the Radius acquisition and capitalize the bank with a strong balance sheet, while also being prepared for a protracted economic downturn. Our decision to strengthen and derisk our balance sheet does have a negative impact on our earnings in the near term. By selling loans and building our cash position, as well as pausing our structured products, we have reduced our use of the balance sheet, and we will report lower net interest income in Q4. We estimate the quarterly impact of lower net interest income to be approximately $20 million when compared to 1Q results. Let me recap some of the positive trends we're seeing and how we're managing through this period. As I mentioned, loan volume was up 79% quarter-over-quarter in Q3 and the credit outlook on our loans has improved, reflecting the resiliency of this asset class, our efforts to support our members and the impact of government stimulus. Post-COVID underwriting is delivering attractive investor returns with IRRs of 5% to 6% for our investors. Investors are increasing their purchases and we're seeing new investors starting to buy loans in the platform in Q4 with pricing and loan sales continuing to improve. We are gradually reopening marketing channels in the fourth quarter and are continuously testing and learning from the performance of our post-COVID loan vintages. In Q4, we expect a consistent increase in originations of between $250 million and $300 million, bringing us to approximately $850 million to $900 million for the quarter. Our reduced cost base and market efficiencies are driving better operating leverage and improving our margins. We have delevered the balance sheet through loan sales, paid down warehouse lines and turned out our other debt to improve the resiliency of our company. Our cash and security balance of $465 million positions us well to manage through this environment and provides liquidity for both Radius and future growth. With all these actions we've taken, we believe that we are well positioned to benefit from an economic recovery. So with that overview of our earnings and our financial position, let me turn it back to Scott for his comments.

All right. Thanks, Tom. I think you summed it up pretty well. I'd just say, overall we feel the recovery is well underway, we feel good about how things are progressing, we feel well positioned to navigate and to complete the transaction with Radius, which we believe will in turn help further accelerate the recovery. Just before I turn it over to Q&A, I would like to say thank you to LendingClub employees. We are eight months into this thing and the working from home and Zoom presents special challenges and I deeply appreciate how everyone continues to soldier on and stay engaged and serve our customers. So with that, Sameer, let's go ahead and open it up to questions.

Great. Thank you, Scott. Before we open it up to questions, as a courtesy to others, we ask that you limit yourselves to one question and a follow-up and return to the queue if you have additional questions. Jack, please open the call up for Q&A.

[Operator Instructions] And the first question will be from Steven Wald with Morgan Stanley. Please go ahead.

Thanks for all the commentary there. It's much appreciated. Maybe one place to start off will be on the Radius deal. And I know you guys - there is a limit to what you guys can say, but certainly you've gone through a lot of steps, prepared a lot of day one sort of stimulation and management steps to show regulators you're ready to go, showed your risk management you filed your Y-9C. I guess I'm kind of curious if there is a way you can sort of speak to whether the filing of the Y-9C is more of a formality or at this point anything that would have been, I guess, derailing to the process, probably would have been communicated at this point? Is there anything you guys can offer on that, in that regard?

Yes. Thanks for the question. I mean I would say look this is just one other step in the process, one further milestone, and process isn't complete until it's complete. We did include in the earnings presentation bit of an overview of some of the things we've been working on, but what I'd say is we continue to believe we're on track for the timeline, we laid out back in February, which puts us at a 12 to 15 months approval process. And again as in our prepared remarks we mentioned part of our repositioning of the balance sheet was really to show that we are ready.

And then maybe as my follow up, I know Tom you threw in there that you guys can run back to operating profitability about $1.5 billion volumes, I believe. I assume that's on a - assume that looks like based on the track record you're on or the trajectory you're on, it looks like that could be as soon as, first half of '21, maybe by mid-year assuming things recover certainly if you were to add Radius on there, I'm curious how much that would, I guess, right-size your ability to add more funding, as I believe last quarter, and I'm curious if you could update us on this. It was about 50-50 of the constraint on your ability to underwrite was due to funding availability and the rest was due to sort of credit concerns. And I'm curious how you think about that and what sort of trajectory you would be on in terms of getting back to the operating profit volume threshold organically versus from Radius?

Well, Steven, couple of things. As we mentioned, we're on a good glide path. We've been very deliberate in growing our volumes to about $250 million, $300 million. We did that this quarter. We expect to do next quarter as well. And really what we've been saying is that we want to see the performance of those vintages. And as we will start to end the year, we'll start to see that and take into account what the environment and put ourselves on a trajectory of getting ourselves back to higher levels of volumes. We commented on 1.5 billion because that's kind of - if you will the traditional business model to give everyone indication of the efforts we put in place to resize our expense base, efficiency in marketing and puts us back to profitability, where we were in the fourth quarter of 2019. We are continuing to grow our cash flow, which is great. We continue to be positive cash flow in our operations. That's all positive With the Radius acquisition, we just think that accelerates our efforts. Obviously with more stability and funding, lower cost funding, we started to benefit from some of the things that - that we get from Radius as far as being an issuing bank and so on. Those things are all continue to be very positive. We will start to grow the balance sheet. So pre-provision revenue will start to grow nicely, we would have to put up the CECL provision, so reported results will be impacted by the provision. But we would be able to start to grow our held for investment portfolio at a pretty delivered rate. So that's the business plan. Obviously, as Scott mentioned, timing is not clear. We're working towards our goal of the 12 months to 15 months and will give you more information as we get closer.

You might want to touch on Tom, just that the - it will - absolutely the addition of the bank charter will improve our earnings profile, like how that flow through the income statement will be a little different.

Yes. So, keep in mind that with the bank we actually earned more, but obviously the income profile will be different, we get a transaction fee in the marketplace lending, whereas in the bank we would prefer all that and get interest income and net interest margin. So the and have to book a provision. So the total income will be higher for loan. The recognition of the income would be over time as opposed to as time of issuance.

Yes. And on your comment on kind of what's happening on platform balance, we - this is also in the earnings presentation, but we're remaining at the moment pretty prudent on the credit underwriting, with about a 40% or 50% production and kind of model throughput, if you will, in addition to the increased prices while we kind of established the performance of these vintages post-COVID. So we are maintaining that. We had said way back in Q1, we are going to maintain it for six months. So we're in month four right now. We'll exit the year with the - or I guess we're in month five now, where we'll exit the year with the full six months where we evaluate that. That - it's our belief that that posture. This has been a question over us as how will these loans do in a recession and a LendingClub given that you are - in your current model, your incentive is to originate, how are you going to manage through it. We believe we're kind of - it's important that we show that we are good stewards of credit. And that's how we're seeing that. So we are seeing the order book building. We are seeing interest increasing. I think in that our existing investors are very encouraged by the data that is coming in, and we are seeing not only existing investors increase their orders, but we're seeing new investors with interest to join the platform because the relative value that we believe are providing in this environment is very compelling.

And the next question will be from Henry Coffey with Wedbush. Please go ahead.

I think it's fair to say you've done everything right in terms of managing through this crisis and building up the balance sheet. When - I know there are a couple of comments on your outlook. I was wondering if you could expand around a few of them including some of your views on net interest income over the next couple of quarters as you approach the bank and other sort of relevant factors?

So, hi Henry, this is Tom. I think the - my comment on net interest income is that with the balance sheet coming down from what was the $1 billion to less than $300 million. We have - we think we reduced net interest income by about $20 million per quarter. So going from a typical run rate of about 25 million per quarter, down to about 5 million. So that's temporary because we haven't deploy the capital. But as you know, deploying that capital into a bank and being able to generate more stable funding and obviously larger net interest margins, we see significant opportunities to grow that interest income as part of our revenue source and they have the durability and predictability of that revenue. So obviously that will be dependent upon our timing of close and the pace of our asset growth, and I'll be able to provide those details when we get better view on timing and size of the balance sheet. So - but we know this is a temporary impact, but we think it's prudent. As you said that position of the company appropriately for the next wave of strategic growth that we've been working towards.

On the other side of the equation, you obviously are pretty deep into thinking about the bank, you talked about certain deposit programs et cetera. What was the loan mix look like? Is it still going to be a business where LendingClub zone originations are - I mean it sounds like it's going to be a business where LendingClub zone originations are now going to be a much bigger part of the bank's balance sheet than originally anticipated,. And I know that they also have their own book of business. So could you sort of give us a sense of what ultimately expect in terms of a loan mix equation.

Yes. Henry, I'll start and then maybe let Tom follow up. Even in the banking framework, we continue to see the marketplace as a very important - playing a very important role in the business. So marketplace is what's going to allow us to serve a broad range of customers, which keeps the marketing dollars efficient and also allows us really build a member base, a broad member base. And we think that the fee income that we're going to be generating off of that is going to help offset some of the provisions to enable us to grow the balance sheet and be generating our own capital. So while we will be participating by holding some of the loans, you know, the majority of the loans going through are still going to be sold to investors. So we'd like to have a good mix. Obviously there is portfolio with ours. Obviously, the loan, the personal loan portfolio as well as our patient finance and our auto loans will obviously be a faster growing, because they will be new to the balance sheet. And the amount of loans that we generate per year allow us to put a portion on the balance sheet and grow it at a reasonable rate. So, I think, we will see a mix - good mix of personal loans and the continuation of some of the portfolios, Radius helping us to diversify the portfolio.

[Operator Instructions] The next question will be from Bill Ryan with Compass Point. Please go ahead.

Questions around your - talk about your origination volume going north of $800 million in Q3 and then targeting kind of $1.5 billion to be breakeven. But you also commented that most of your volume right now is from existing customers. Just kind of looking at it, what percentage is coming from existing customers? And when do you think you might start to open up a little bit for new customers? And is that kind of instrumental and driving it up to the $1.5 billion? And second question, might be three, but would be adjusting as the use of proceeds changed at all in light of COVID-19 and what's happened in the economy? Thanks.

Tom, I'll start again. So, yes, we have been really focusing on existing members. Two reasons right now. One is with the more limited funding capacity right now, we want to make sure we're there to reward our loyal customer base, first, and that they can get access to credit. That's reason one. Reason two is they obviously cost a lot less to acquire, you can see that in our marketing expenses; and reason three is they perform significantly better on credit, but that's not a - that's not a long-term strategy. That's just really kind of in the - this current time period, we thought was the right focus. We are in the process of opening back up marketing channels. So we're still majority repeat call it in 80-ish percent range. But we are opening back up the marketing channels to begin to bring new members into the club and that those are investments that we absolutely think are important to make in our future. And so you'll see that mix continue to evolve over the coming couple of quarters as we come out of this. And to your question on proceeds, yes, we are seeing a shift. I kind of hinted at that in the prepared remarks, both the evolving consumer behavior as well as our evolving strategy that we are working on, which is, you know, you've probably seen consumers are deleveraging more broadly. So we're seeing the credit card refinance use case come down. It is still a massive, massive market that - it comes down. There are still close to, I think it's $900 billion in outstanding there, but we are seeing an increase in things like major purchase, home improvement loans and those kinds of things. So we're adapting our approach to fit those use cases.

Yes, Bill, I would just add. It's kind of mentioned I think this is probably the cleanest this quarter where you can really see the return on investment that we were getting from the marketing dollars over the last few years. Scott mentioned how frequently consumers come back, borrowers come back for a second loan. This is the utilization that we've been talking about for quite some time. And so our ability to repeat increased utilization is really, really important, and it really has not been seen, because we've grown so fast. We were trying to explain this to investors nicely at this quarter on how you can generate loans of pretty low amount. And that can be part of our future as we have those members and engage them in normal way.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Sameer Gokhale for any closing remarks.

Thank you, John and thank you all for joining us today. If you have any questions, please contact Investor Relations and we'd be happy to assist you.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.