LendingClub: Signs Of Desperation

Summary

• LendingClub offered a brand-new promotion to retail investors promising a 50bps bonus for new deposits to LendingClub in Q2.
• Investors, both retail and institutional, have backed off LendingClub due to the perceived risk of consumer debt amid a pandemic that has laid off millions of workers.
• At LendingClub's ~$2.5 billion Q1 originations pace, a 50bps discount applied to all investors would result in ~$10 million of costs, or a roughly 8 point impact to Q2 margins.
• LendingClub's liquidity looks thin as it is without additional costs.

Almost the entire market rallied in May, especially small cap stocks, with the Russell 2000 advancing 11% during the month. One major exception, however, is LendingClub (NYSE:LC). The once-innovative and market-leading fintech company, which focuses on providing unsecured consumer debt to borrowers, has been pressured into an existential crisis by the coronavirus. LendingClub's Q1 earnings, released in early May, showed a company that was preparing to see originations grind down to near-nothing, while the company tightened its belt and laid off one-third of its employees.

Shares are currently trading close to 52-week lows, and have lost more than 55% year to date.

Data by YCharts

This article will serve as an update to my prior article on LendingClub, with a specific update on LendingClub's crisis-management strategy: as a platform investor myself in LendingClub Notes, I was very recently alerted to an offer that LendingClub is proposing to retail investors in the months of June, July, and August. The company is planning to offer a 50bps bonus for all new deposits by investors, highlighting that the company is having issues funding new loans.

As a refresher, the core bearish thesis for LendingClub hinges on the following points:

• Pandemic layoffs have made unsecured debt very risky, and LendingClub is facing drained demand from investors to fund its loans
• In order to continue issuing loans and generating the origination fees that make up ~80% of its revenues, LendingClub has to take on more of its own loans onto its balance sheet, greatly increasing its credit risk

And a look as well at how originations have trended so far this year:

Figure 1. LendingClub originations trends by funding source

Source: LendingClub Q1 earnings deck

In short: the latest bonus offer from LendingClub is a major sign of desperation. Resist the temptation to catch a falling knife and protect your capital by investing elsewhere.

The bonus offer and what it tells us about LendingClub's FY20 originations

Here's the marketing details on the bonus offer that LendingClub is currently offering to retail investors:

Figure 2. LendingClub bonus offer

Source: LendingClub email promotion

It's a very simple promo: deposit new money into LendingClub and invest it in Notes (it can't just be sitting as uninvested cash in the account), and receive a 50bps bonus payment (here's a link to the full T&C's of the offer if you're curious). The company has been known to issue promos in the past, but few in the form of cash. Several years ago, LendingClub partnered with United Airlines (UA) to offer 1 MileagePlus mile (worth roughly $0.01) for every $1 invested on the LendingClub platform. Technically that would have been a 100bps promo at the time, but it wasn't a cash payment - and United was certainly footing a part of that bill. From time to time the company also offers referral-type bonuses - but in general, attracting investment dollars to fund loans from retail investors isn't in LendingClub's normal modus operandi, as the company focuses primarily on banks and institutional investors (which made up roughly two-thirds of originations funding in 2019).

Retail investors make up the smallest portion of LendingClub's originations (roughly 4-5% of total volumes). To me, LendingClub's directed outreach to get more funding dollars is a sign of how desperate LendingClub is to attract fresh capital - in its investor presentation in May, LendingClub posited that "loan volumes expected to be down approximately 90% reflecting current loan environment," largely as a result of platform investors taking steps to protect their capital from risky investments.

This offer is very recent, having only been implemented on June 1. We don't know if LendingClub plans to do anything similar for banks and institutional investors. If applied only to retail investors, this program will cost very little for LendingClub - retail investors' ~4% contribution to Q1 originations of $2.5 billion amounted to only ~$100 million. Assuming Q2 originations keep the same pace as Q1 (which is highly unlikely), retail investors' 50bps credit would cost LendingClub less than $1 million.

The risk is if this promo has any spillover effect to other sources of capital. Perhaps in seeing the consumer offer that LendingClub has put out, institutional investors and banks will also demand a discount. At the other extreme end, if LendingClub were to credit all of its outside funding sources with 50bps (80% of $2.52 billion in originations in Q1), the company could spend up to ~$10 million to attract new capital in Q2 alone, again assuming flat originations volumes (though as originations fall, so does revenue, and promo costs as a percentage of revenue would along with it). Q1 revenues, meanwhile, were only $120.2 million, so this could be up to an eight-point hit to operating margins (though as I previously said, this is the other end of the extreme, and it's unlikely that banks and institutional investors would receive as sweet of a deal as retail investors).

As a refresher, LendingClub's liquidity picture already isn't incredibly healthy, so added costs of any magnitude will be adverse. As of the end of Q1, LendingClub had $294 million of cash left on its balance sheet against $110 million of debt drawn on its revolver, making for $184 million in net cash. As I calculated in my prior article, LendingClub's cash operating expenses amount to roughly $128 million per quarter, while servicing fees (that don't rely on new originations) bring in ~$50 million of revenue per quarter.

How should investors react?

Investors should closely monitor how LendingClub is reacting to the unprecedented bind that it's in. The company's brand-new deposit promotion advances the idea that demand for LendingClub's originations is very low, and requires bonuses to stimulate. Further and more dramatic actions may be needed in order for LendingClub to maintain anywhere near the same pace of originations as it has in prior quarters.

With no light at the end of the tunnel for LendingClub yet, investors should continue to stay on the sidelines.

Analyst’s 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.