LendingClub Corporation (LC) Q4 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the LendingClub Fourth Quarter and Full Year 2020 Earnings 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 fourth quarter and full year 2020 earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO; and Tom Casey, CFO. Please note that in addition to the presentation we usually provide with our quarterly results, we are also sharing a LendingClub Bank presentation that provides information about our business, including our new banking capabilities. You can find both presentations accompanying our earnings release on the Investor Relations section of our website. 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, future products and services, the effectiveness of certain strategy initiatives, anticipated financial results, and the impact and benefits of the Radius acquisition and resulting bank charter on our business. 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 is filed with the SEC as well as our subsequent filings made with the Securities and Exchange Commission, including our upcoming Form 10-K. 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 release and related slide presentation. The press release and accompanying presentations 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. Good afternoon, everybody, and thank you for joining us today. We are very excited to share the update on our business, now that the acquisition of Radius is complete. We've worked long and hard to get to this point, and we are very bullish about how we're positioned to add value to our customers and deliver consistent and sustained multiyear earnings growth for our shareholders. It's really hard to imagine a better time to be launching a digital bank. We have got a lot of information to share today, and the financial expression of our business will be changing considerably. So, Tom and I are going to split this up. I will focus my time on how the addition of the bank enhances our business and enables us to deliver on our strategy, and I'll let Tom provide the details on last quarter's results and how the acquisition informs our financial outlook for the year. When we launched back in 2007, LendingClub's vision was to leverage technology, data and our marketplace model to transform the banking industry. We began by bringing a traditional credit product, the installment loan, into the digital age by moving it online, broadening access, lowering costs and delivering a fast and frictionless experience. We redefined the category. And by 2019, personal loans were the fastest growing segment of consumer finance, and we became the largest personal loan company in America, generating more than $1 billion in loan volume per month and helping more than 3 million customers lower their cost of credit and get on the path to eliminating their credit card debt. Getting out of debt is in fact our members' number one goal, and they love us for what we're doing for them. Our NPS score is approaching a truly outstanding 80s, that's well above many leading brands and traditional banks. And the pandemic has demonstrated that they prioritize our loans above many of their other debt obligations, including even credit cards, and half of them returned to us again within five years, providing us a virtually free source of loan volume, which we reward with a further simplified process and even lower rates compared to their first loan. Easy access to responsible, low-cost unsecured credit is a primary pain point for our members, and it represents a huge immediately addressable market that's expected to grow at more than 20% annually over the coming years. But, it's not the only pain point, and our mission to empower our members on their path to financial health doesn't end here. Of note, our customers are not the underbanked or those shut out of the financial system. These are high income, highly creditworthy individuals who are already fully utilizing bank services. In fact, they are some of retail banking's most profitable customers. It's just working out better for the banks than it is for them. That's because together with their higher-than-average income, they also have higher-than-average debt, including credit card, auto and student loans. They want to put this debt behind them, and they are highly motivated and willing to take action to get there. And as a digital marketplace bank, we can now do so much more to help. And our members tell us they are ready and eager for us to do so. In a recent survey, 83% said they're interested in more products and services from LendingClub. With the digital bank acquisition closed, we can take the next step. First up, we'll be building on Radius' multi-award winning online and mobile deposit offering to make it very easy for our customers to manage their lending, spending and savings in a holistic fashion. Because we're vertically integrated, we can capture more value, both from lending and from spending, and can use this, together with the behavioral data we'll be collecting to offer powerful benefits and value to our customers. This sets LendingClub apart from the neobank and fintech competition. What's even more exciting is that the bank is being added to an already formidable platform with two sizable benefits. First, as you can see on slide 9 of the LendingClub Bank presentation, we have incredible data superiority. We have 14 years of history on $60 billion in loans to millions of customers, informed by rigorous testing, resulting in 140 billion data cells added to our proprietary database. Access to this vast amount of data gives us a significant competitive advantage. Our team of more than 130 data analysts and scientists mine this historical data with leading-edge machine learning and AI analytic techniques to continuously refine our dozens of proprietary models to optimize fraud risk, repayment risk, loan exposure and loan pricing. And it's working. Our experience shows that our proprietary scoring system is 20 times more effective than traditional credit scores, such as FICO, at predicting defaults. As a result, we can approve more borrowers, offer significantly lower interest rates and price competitively for attractive risk-adjusted returns across the credit spectrum. Benchmarking data from one of the leading online aggregators shows that our loan offers are priced very competitively and are very likely to be ranked as best-in-class. And several independent studies, including those conducted by the Philadelphia Federal Reserve researchers, confirm our ability to make credit more affordable than traditional alternatives. Coming out of the pandemic, the strength of our underwriting has now also been cycle-tested. Losses on loans issued pre-COVID are in line with our pre-pandemic expectations, and loans issued since the pandemic are some of our best-performing loans in recent years. So, we haven't just collected a wealth of data. We're leveraging it, and it's clearly giving us an edge. Another key differentiator is our technology infrastructure. Our tech team encompasses nearly 400 LendingClubers. We built proprietary software and systems that enable us to deliver seamless, highly automated access to credit and deliver a fantastic customer experience. We've issued 13 patents and have 27 pending. It would take others many years and a significant capital outlay to try and replicate the competitive mode that we've created. With the acquisition of Radius, we're adding to our competitive advantages by evolving to a unique and powerful new business model, a marketplace bank. As you can see on slide 10, this model wins against both traditional banks and against fintech marketplaces. Versus banks, we expect to grow more rapidly, fueled by the combination of interest income from our high-earning assets together with significant fee-based income from our capital light marketplace. We'll be even more efficient at customer acquisition supported by our national footprint and our ecosystem of funding partners that allow us to serve a broader range of customers than a typical bank. And we'll be highly adaptable at a lower operating cost as a digital-first entity unencumbered by legacy tech infrastructure or high cost branches. We also have advantages over pure fintech marketplaces, the limitations of which we understand better than anybody. And that's why we've evolved our business model. Versus fintech marketplaces, our marketplace bank will be more resilient with access to stable funding, a recurring and sustained revenue stream, and a clear and established regulatory framework. And we'll be able to reach higher profitability, given our lower funding costs and higher earnings per loan. All of these advantages position us well to capitalize on a clear trend that has been accelerated due to COVID, the move to digital banking. Bank is no longer a place you go. It's a thing you do, increasingly from your mobile phone, and consumers are now more than ever weighing the importance of that experience versus proximity to a bank branch. With one of the best mobile experiences in the industry, we're starting from a good place here. I've been with LendingClub for more than 10 years, and I have never been more excited about the combination of capabilities and market conditions for us to achieve our ambitions and transform the industry. Our marketplace bank begins today with industry-leading loan and deposit products, a strong brand and loyal customer base, considerable technology and data advantages, and a differentiated offering that allows us to better serve an expanded total addressable market, which will allow us to drive sustained earnings growth. Near term, personal loans will be our primary economic driver, and we plan to grow originations by 45% and revenue by 55% this year. As Tom will lay out for you in a minute, the growth in earnings power of LendingClub will become quite clear after we absorb the costs and accounting implications of operational integration. As a team, we are very committed to executing on our strategy and building long-term value for our shareholders. Together with our core unsecured lending capabilities, our digital bank gives us a highly differentiated offering that positions us well to compete while providing cost-effective financial solutions for our customers. It is our intention to stay disciplined, execute and deliver in the near term while investing for the future to achieve our broader ambition and redefine banking for our customers. Okay. With that, I will pass it over to you, Tom.

Thank you, Scott. As you just heard, we are tremendously excited about the future with the addition of our new banking capabilities. After my time going deeper into some of the areas that Scott touched on, but we'll start off covering highlights from Q4 earnings. We're very encouraged by our positive business trajectory in Q4. We increased originations to $912 million, exceeding the high end of our guidance range and reflecting growth of 56% from the third quarter. We ended the year with $525 million of cash, reflecting the sale of $470 million in loans in the second half of 2020 as we prepare to capitalize the bank with cash to support strong growth. By maintaining such a high level of cash, better loans, we experienced a temporary and anticipated reduction in net interest income. For the fourth quarter, the impact was about $20 million in revenue compared to 4Q 2019 and $8 million compared to the third quarter of 2020. Our results for the quarter also did not include onetime benefits related to loan sales, and loan and asset revaluations that occurred in the third quarter. So, the story for the quarter was pretty straightforward. Transaction fees up 77% from Q3 on the back of 56% origination growth, offset by lower net interest income, reflecting prior loan sales and nonrecurring asset revaluation benefits in Q3. With that, let's get into some of the financial benefits of our marketplace bank that Scott referenced and how this sets us up for 2021 and beyond. As seen on slide 11 in the LC Bank presentation, the economics of owning a bank are truly compelling with substantial and really achievable benefits. With the vertically integrated digital platform, we capture the best of the marketplace and the bank, creating a self-sustaining high-growth and highly profitable business with structural advantages. Let me outline some of these benefits. First, with access to banking capabilities, we have significantly enhanced the resiliency of our business, enabling us to better serve our members. Deposits are much more stable compared to warehouse funding used by other fintech marketplaces. Second, access to low-cost deposits also reduces our borrowing cost dramatically, allowing us to generate a new and growing stream of recurring earnings. This will help drive strong and sustainable profitability. Third, as a bank, we become vertically integrated, reducing our dependency on others and eliminating the fees we paid to third-party issuing banks for originating the loans on our behalf. To put this into some perspective, over the last two years, our partner banks received approximately $20 million per year for originating our loans. Fourth, we intend to hold prime loans comprising 15% to 25% of our total originations while selling the rest through the marketplace. This leverages the unique capabilities of our platform and aligns our interest with investors. Together, we can balance the recurring and durable bank revenue stream with the capital-light marketplace fee-based revenue stream. And fifth, our marketplace is fueled by a diverse investor base that allows us to continue serving borrowers across the credit spectrum. This has enabled us to create a hugely efficient marketing engine while building a more inclusive brand that is aligned with our mission to empower members on their path to financial health. Now, let's talk about how some of these benefits translate into enhanced financial performance. I'll start with deposits. As you can see on slide 12, the benefits of deposit funding are very clear. Compared to pre-pandemic levels, our borrowing costs should decline by approximately 90%. Yes, 90%. In 2020, the average cost of warehouse lines was 3.3% compared to our bank's deposit cost today of about 35 basis points. To put this into perspective, for every $1 billion in assets we hold, we will now save approximately $30 million per year in interest expense. As I mentioned earlier, deposit funding is more stable than warehouse funding, which can dry up when market volatility increases. So, there is less funding availability when you need it. Any deposits and replacing these other funding vehicles is transformative to both the economics and the resiliency of our Company and will enable us to drive a new stream of recurring revenue. Our bank also has an award-winning platform that brings $2 billion in deposits, which will help support our future growth. In addition to lowering our funding cost of deposits, our new marketplace bank will capture significant financial benefits from being a bank and having a marketplace. As you can see on the right-hand side of slide 14, for every $100 million of loans we originate, we generate about $4 million through an origination and servicing fee when we sell the loans in the marketplace. The vast majority of this fee-based revenue is realized immediately and without requiring a significant amount of capital. However, it is highly dependent on origination volume. We can now bolster this revenue stream with bank revenue generated by loans held for investment on our balance sheet. As you can see on the left side of the page, every $100 million of loans we hold on the balance sheet should generate additional marginal profitability of approximately $12 million. And when you compare that to the $4 million in the marketplace, that's 3 times more. And this recurring revenue is not dependent on originations in any given quarter. However, from the standpoint of GAAP profitability, loans held for investment have accounting requirements, such as CECL allowance for credit losses and the deferral of origination fees, which results in a loss at the time of origination. CECL provisions are less of an issue when loan balances are flat or growing at a low level. In contrast, we expect to grow loans at a relatively rapid pace. Therefore, the cumulative layering of expected credit losses upfront will pressure short-term GAAP income. But, as we continue to grow this portfolio, we'll establish an ongoing annuity of future earnings. So, I want to underscore that even though GAAP accounting results in a front loading of expenses as well as to revenue, the cash economics of retaining loans are very attractive. As growth normalizes and the impact of upfront expenses recognition becomes less pronounced, GAAP and economic profitability of loans held on the balance sheet will converge. The combination of revenue streams for the bank and the marketplace should enable us to grow faster and better navigate through challenging periods. In addition to the power of the marketplace bank model, we benefit from being a leader in a very attractive asset class. Slide 15 shows that even after adjusting for credit losses, LendingClub's direct-to-consumer personal loans generate risk-adjusted margins of approximately 7.5%, representing more than 2 times the margin for traditional banks. So, as we increase the proportion of consumer loans over time, we'll generate a highly profitable earnings stream at industry-leading margins. With that overview of the financial drivers of our new business model, let me provide some context and details behind our near-term outlook. I'd note, our guidance excludes any potential impact from the FTC, which we hope to get resolved by the end of the year. 2020 was a year of repositioning as we navigated the pandemic, reduced our fixed cost by 30% and prepared for the acquisition of Radius. 2021 will be the year in which we prime the pump as we begin to build our consumer loan portfolio, integrate the bank and accelerate our origination growth. All this will set the Company up to generate strong multiyear earnings growth. A reminder, with our new model, there's no longer an immediate one-to-one connection between origination volumes and revenue. That's because the loans we hold, both origination fees and net interest income will be recognized over time rather than at origination. And you can see this dynamic play out as follows: For Q1, we expect originations to grow faster than revenues because of the deferral of origination fees. We expect originations to grow 30% to 40% versus last quarter, while revenues will be growing at 15% to 25%. However, when you look at the full year, you see the opposite where revenues outpace originations, driven by growth of interest income. For the year, we expect origination growth of about 45% and revenue growth at 55%. You can see a similar dynamic of timing differences play out in our net income, which is impacted not only by the deferral of revenue at origination but also by the upfront CECL-driven recording of charge-offs that occur over the life of the loans. Accordingly, we expect to report a GAAP net loss in 1Q ranging between $75 million and $85 million. And for the year, we expect a net loss of $175 million to $200 million. Now note, this loss is almost entirely due to the change in accounting convention for loans held at the bank due to adopting CECL accounting and origination fee deferrals. I want to note that we also included roughly $20 million of onetime costs related to the acquisition of Radius. Now, these investments will prime the pump for recurring high-margin earnings for years to come, and we expect to earn more than 2 times the amount of the CECL provision over the life of the loan. Our outlook is consistent with the financial plan we submitted to the regulators for the bank acquisition. Over time, we anticipate that our GAAP earnings will drive industry-leading ROEs and catch up to our high-growth cash earnings. I also wanted to provide you with two additional details. We used approximately $140 million of our $525 million cash position for the purchase of Radius. We also capitalized the bank with an additional $250 million of cash, bringing the LC Bank equity to approximately $440 million. Staying on the theme of capital. At the end of 2020, we had a valuation allowance of $211 million against our entire deferred tax asset. Over time, as we generate GAAP earnings, we expect to reverse this valuation allowance, which will substantially increase our tangible book value and generate substantial savings on cash taxes. We went through a lot of information today, and I appreciate your interest in the Company. Before we get into questions, let me leave you with three key takeaways. First, we have a cycle-tested and differentiated business model with data and technology advantages. Second, our unique business model allows us to leverage the benefits of both our capital-light marketplace, and our bank enables us to further disrupt the banking industry. And third, we are a leader in a large and growing market with substantial growth ahead. With about $440 million of capital and a business that will generate earnings to support future growth, we are very-excited about the road ahead and how well-positioned we are to create significant shareholder value. Now, let me open it up for questions.

[Operator Instructions] Our first question today will come from Steven Kwok with KBW.

Great. Thanks for taking my questions. And congratulations on the closing of the Radius acquisition. I guess, the first question I have was just around pro forma tangible book value post the Radius acquisition, if you could provide an update of that. And then, you guys have given us highlights around the impact of the acquisition. Are those terms still the same around the beneficiaries and stuff, as we think about it?

Hey Steven, this is Tom. Yes, let me answer your first question and then clarify your second one. So, on the tangible book value at the bank, as I mentioned in my comments, it's about $440 million. So, we ended the year -- excuse me, at the end of the year, we were -- the total equity was about $750 million. So, we still do have additional capital at the parent. But, inside the bank, we've got about $440 million of tangible book value. The second question you had, Steven, just if you could clarify that you mentioned something about the benefits?

Yes. At the time of the Radius acquisition, you had given us -- in terms of what the benefits were from the Radius Bank. Are those still largely intact on amount funding, investments and bank economics?

Yes. They are, Steve. Overall, we continue to feel very good about the acquisition. Things have changed a little bit, obviously. Rates are much, much lower than they were. And Radius has delivered a lot more deposits than we originally modeled. So, clearly, that's a much bigger benefit. But, we still get all the benefits that we talked about as far as the issuing bank fees and, obviously, the lower cost of funding that I mentioned in my prepared remarks are very significant, so. And then, obviously, the interest income is quite larger than we expected again because of where deposit costs are right now. So, feel very good about the acquisition and the profile that Radius has as we get started integrating them this quarter.

Got it. And if I could just sneak one last one in. Just around the GAAP consolidated net income. Understanding that this year, you have the onetime acquisition cost along with the CECL impact you’ve got, but when should we expect it on a GAAP basis for you guys to become profitable as we continue this acquisition, along with the loan growth?

Yes. So, we haven't given long-term guidance, Steven. Obviously, lots of things to work through this year. We obviously just closed the transaction. We gave you a quite a bit of information on the new model and some of the key drivers of our profits and revenue. Just to highlight a couple of things to help you navigate. As we tried to show you that the deferral of the origination fee and the provision obviously put pressure on our reported results, but I'm referring you back to page 14 to show how fast the earnings recover. You can see that pretty significantly the -- those two deferrals come back pretty quickly within the first nine months or so. So, we're not saying when we're going to be GAAP profitable, but I did say in my prepared remarks that most of the -- almost all of the GAAP loss this year is really the CECL accounting provisions that require losses to be recognized upfront and the deferral of fees, just some quick math for you, if you were to take those 2 items, that's about $165 million of the loss right there, just those two items alone. And then, you add the additional $20 million of integration-related expenses that appreciates about the midpoint of our guide.

Yes. I'll just add, Tom -- I mean, Steven. We're -- our goal here is to build a high growth, high profit machine that is driving really sustainable growth over a multiyear period. Getting to GAAP profitability soon would actually be pretty straightforward, based on the numbers Tom said. But we're making a conscious decision to add the loans to our portfolio because they're going to drive -- as you can see in the numbers, overall, as an enterprise, for every given dollar of loan origination, we can drive 30% to 40% more in earnings than our historical model. And this is really just a timing difference. So, part of the timing of GAAP profitability is going to be based on our growth rate, and our plan is to continue growing.

Our next question will come from John Rowan with Janney.

Good afternoon, guys. Just to be clear, I know there's a lot of talk about CECL. Is Radius -- Radius has already adopted CECL, correct? So, there's not a one day catch up on the allowance as you adjusted for higher lifetime losses. Is that correct?

Yes. John, no, they were not subject to CECL. So, they've -- we've adopted CECL as part of the acquisition. I did leave that complexity out of my narrative. But yes, they will have a conversion amount. We're working through the purchase accounting now, but there will be a conversion amount to establish a new provision. We recognized that in the first quarter. And that's included in my guidance.

Okay. So the day one CECL adjustment to the allowance for Radius Bank is included in the GAAP loss figure for 1Q and for 2021, correct? Just to make sure I have this right.

That's correct. And that's one of the reasons why you see that loss so large in the first quarter. That's part of it.

How much -- I mean how much you’re bringing up their allowance? And why is the day one CECL adjustment here not just a charge to equity as it was on day one 2020?

Yes. So, we didn't own them on day one, 2020, and they did not adopt CECL. So, as part of the acquisition, since we had already adopted CECL in our own books, we adopt CECL for them through purchase accounting. And that's the piece I was just referring to. So, there is a day one charge as part of our purchase accounting. I'll break that out for you in 1Q. It is in our guidance, though. We've finalized the number, and we're in the process of finalizing that number, but it's all in my guide right now.

Okay. And then, just last question. You guided us to how loans held through the bank are 3 times more profitable versus the traditional marketplace model. Has there been any change in the guidance that you provided that about 10% of the loans are going to be funded -- 10% of the LendingClub loans are going to be funded through Radius, or is that -- is there an update to that guidance figure?

Yes. I gave you in my prepared remarks that we're targeting about 15% to 25%, depending on the final volumes for the year. So, we think that's a good range to again build a new recurring revenue stream that accelerates our earnings growth, but at the same time, maintains a -- plenty of volume for our partners on the investor side to buy our loans.

I just want to make sure everybody is tracking, when we say funding through Radius. What we're referring to, to make sure that's the answer to your question is, what percent of loans are we holding, that's 15% to 25%, what percent of loans are being sold through the marketplace, that's 75% to 85%. That's it.

And our next question comes from Henry Coffey with Wedbush.

Henry, I think you might be on mute.

We'll go ahead and go to our next question from Bill Ryan with Compass Point.

A couple of questions. First off, in the discussions with regulators, and I know it's probably baked into your guidance, but did they put limitations on, if you will, sort of the retention of loans going forward? Because I know a lot of -- thinking back to some of the companies I followed that converted to banks, they were limited in the amount of growth on balance sheet that they could have, whether it was deposits or loans. So, if you could talk about any possible restrictions. And then, the second thing, on the CECL side of the equation, I had in my note sort of a 6% to 7% loss reserve upfront established on new originations. Is that still the right number? And when will kind of charge-offs follow behind it, over what kind of time period? Thanks.

Yes. So, the first one on the restrictions, all the information we provided to you is what we've used for our regulatory approval. So, these are -- the guidance we gave you reflects that. And obviously, with any approval process, there are business plans that we lay out. And so, our profile that we're showing you today is consistent with that. We don't see any of the agreements we made with regulators causing any concern on any of the things we laid out for you today. So, we feel that this is a very, very good profile. And the accelerated growth that I had talked about is consistent with that. With regard to CECL, year six to seven is what I would call on a nominal basis. So, the five I showed you was on a discounted basis. And so, the recognition of the actual charge-offs, these have a duration typically on our three-year loans, about 1.5 years. So, your peak losses are going to come in maybe in the 12-month timeframe. But, they'll come in over the life of the loan as opposed to, as you know, the CECL charge is upfront…

Right.

Go ahead.

Just a question, you said the discount. So, you approach -- or you're taking the discounted valuation approach to CECL?

That's right. So, it takes about a point off of it, Bill. So, I showed you five on day one. And then, the numbers I showed you on page 14 are net of any additional CECL increases over time, if any.

[Operator Instructions] Seeing no further questions, I'd like to turn the call back over to Scott Sanborn for any closing remarks.

All right. Well, as I hope you could hear in our prepared remarks, myself and the rest of the team are very excited to take this combined business forward. And we thank everybody for their patience. We know we were a little delayed in getting this out to you. And we look forward to talking to many of you offline.

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