Lending Club's Near Future Looks Gloomy

| About: LendingClub Corporation (LC)

Summary

Lending Club has a lot of cash but its expenses are growing.

Management is being forced to adopt business model changes that increase costs and risks.

It looks inevitable that losses will be incurred for some period of time and that greater risks will need to be taken.

On May 13 my article seeking to value Lending Club (NYSE:LC) was published on SeekingAlpha. A number of commenters took me to task for not having valued the cash on the company's balance sheet. I responded that in the circumstances, I did not know how much value to give to the cash. More recent disclosures have convinced me that the cash should be given little weight in valuing the company because the company is incurring increasing expenses, seems likely to endure a period of significant operating losses, and may have to use the cash to support the platform in other ways.

Disclosures in the Lending Club Form 10-Q that was filed May 16th and in an 8-K filed the same day suggest to me that at least for the near future, the company will be in survival mode and, as part of that mode of operations, will change its business model significantly. Those changes may permit survival, but they do not seem to me to embody the strengths that the company was built on, and they will require increased costs. Here is an excerpt from page 63 of the 10-Q report:

"In the five business days since we announced our review and resignation of our CEO, we have experienced a slowdown in a significant amount of investment capital available on our platform and may not be able to attract additional investors to invest in loans, or we may need to grant investors significant inducements in order to attract capital or use our own capital.

"As a result of the circumstances relating to our internal board review into certain private loan sales to a single institutional investor in contravention of its requirements and other matters, and the resignation of our former CEO, a number of investors that account for, in the aggregate, a significant amount of investment capital on the platform, have paused their investments in loans through the platform in the last five business days. It is possible that these investors may not resume investing through our platform. As a result, we may use a greater amount of our own capital, compared to past experience, to invest in loans.

"In order to obtain additional investor capital to our platform, we may need to enter into various arrangements with new or existing investors and we are actively exploring several possibilities. These arrangements may have a number of different structures and terms, including equity or debt transactions, alternative fee arrangements or other inducements including equity. These structures may enable us or third-parties to purchase loans through the platform. Such actions may have a material impact on our business and results of operations and may be costly or dilutive to existing stockholders. There is no assurance that we will be able to enter into any of these transactions, or if we do, what the final terms will be. These actions likely may have material adverse impacts on our business, financial condition (including our liquidity), results of operations and ability to sustain and grow volume."

A company that is under attack is well advised to make bleak disclosures to protect itself from securities law liabilities. But even by those standards, the foregoing is gloomy news. Basically, it says that the business model is broken and that the company is investigating how to fix it. Management may or may not find a way through.

In addition, see the next set of disclosures, which are particularly bleak if one thought that Lending Club's loan sales were more final than most securitizations:

"A relatively small number of investors account for a large dollar amount of investment in loans funded through our marketplace and we may be required to increase our repurchase obligations to attract additional investors.

"A relatively small number of investors account for a large dollar amount of investment in loans funded through our marketplace and we may be required to increase our repurchase obligations to attract additional investors. Historically, we have limited our loan or note repurchase obligations to events of verified identity theft or in connection with certain customer accommodations. To attract additional investors, some of which are beginning to purchase loans, and seek to subsequently securitize such loans, we have increased the circumstances and the required burden of proof of economic harm under which we are obligated to repurchase loans from these investors. While these repurchase obligations are consistent with institutional loan market standards, such repurchase obligations could negatively affect our business and results of operation.

"In addition, if a large number of our existing investors ceased utilizing our marketplace over a short period of time, our business could be temporarily interrupted and we may decide to use our capital to fulfill regulatory or contractual purchase obligations or support short-term marketplace equilibrium as new investors complete the administrative and diligence updating processes necessary to enable their investments. We may use our capital to invest in loans associated with the testing or initial launch of alternative loan terms, programs or channels to establish a track record of performance prior to facilitating third-party investments in these loans."

In case anyone does not recall, it was the reps and warranties on securitized loans that cost many banks and other securitizers billions of dollars in the aftermath of the GFC. Lending Club is now having to go down the road that leads to such risks. It is a costly road if one is to be certain that the reps and warranties are true, but even more costly in arrears if one does not incur the costs up front.

Expenses, expenses

In addition, one can see that expenses, rather than being pared, as I might have hoped management might do as part of a revised business plan, have to be increased to assure the market that the control breaches that led to firing of the CEO have been fixed. In this regard, see the letter to stockholders dated May 16, 2016 here. See also additional measures the company is taking here. It appears that management has no choice but to pull out the stops to save the enterprise. But the costs will eat up a great deal of money.

The value of all that cash

The recent 10-Q discloses about $683 million in cash, $104 million in restricted cash, and $284 million of securities held for sale. That is indeed a lot of liquidity. But much of it will be needed in order to survive. How much I would not venture to guess.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.