LendingClub: Tremendous Upside If The Economy Continues To Improve

Summary

• LendingClub's stock is down 50% YTD, making it one of the few stocks that hasn't participated in the overall market rally.
• The near-term outlook is bleak, with the company guiding for Q2 loan originations to decrease 90% from the previous quarter.
• If your view is that the economy continues to improve through 2020 and into 2021, LendingClub's stock has tremendous upside.

Overview

LendingClub (NYSE:LC) is a peer-to-peer platform that connects borrowers with investors. Borrowers go to LendingClub's website, fill out their information, and in a day or two, they receive their loan. Investors can then log onto LendingClub's website and choose loans in which they wish to fund.

The peer-to-peer lending model works best when economic conditions are good, credit is flowing freely, and peer-to-peer investors are willing and able to purchase loans. With today's conditions, there is obviously added uncertainty to the business model. Peer-to-peer platforms, like LendingClub, haven't been through a recessionary cycle. LendingClub was born out of the previous recession as institutions were reluctant to extend credit to borrowers.

With loan originations decreasing, LendingClub has an uphill battle to fight. Additionally, yield spreads to peer-to-peer investors are wider than they have ever been, but it still may not be enough. If LendingClub is unable to sell their loans, they will be forced to keep them on their books and potentially take sizable losses.

LendingClub's stock is no doubt one of the more riskier plays; high-yield unsecured consumer debt and a recession generally isn't the greatest recipe. However, we believe that these risks have been more than fairly priced into the stock's value. We view LendingClub as a potential investment opportunity for more speculative investors.

Data by YCharts

Revenue Is Suffering Due To Originations, But This Should Come As No Surprise

LendingClub earns money through origination fees that range between 2% and 6%. Additionally, they collect servicing fees on monthly principal and interest delivered to investors of 1% each month. As a result, revenue is highly correlated with the amount of loan originations that the company is able to churn out.

Since reaching a peak in the 3rd quarter of 2019, originations have slowed over the previous two quarters. Further, the company is forecasting for a 90% reduction in quarter-over-quarter loan volume in Q2.

As a result of declining originations, revenue has decreased from $175mm to $99mm during that same time period. Also contributing to the decrease was a $64mm revaluation of loans held on their balance sheet.

Data by YCharts

LendingClub is sacrificing origination volume for quality, which should come as no surprise. From the latest earnings call transcript,

new originations are significantly different from Q1 with even higher income, higher FICO and lower payment to income ratios; new loans are heavily focused on our existing 3 million members who have demonstrated successful past payment history with LendingClub. This is because loans to existing members have historically exhibited significantly lower losses than loans for new members with similar credit profiles. They also come at a much lower cost of acquisition.

As a result, investors should see this as a positive, and not a negative. Financial institutions are doing the same thing. As economic conditions improve, loan originations will likely recover. The main concern for potential investors in LendingClub is whether or not they have enough liquidity to survive.

Liquidity Isn't A Primary Cause For Concern... For Now

At the end of Q1, LendingClub estimated that they have ~$550 million of net liquidity on their balance sheet, which they built up at the beginning of 2020. The company believes that it has enough liquidity to last through the end of 2021 in a variety of stress scenarios.

If the economy continues to improve throughout 2020, it appears that investors have nothing to worry about from a going concern perspective. If the economy takes longer to bounce back, LendingClub may be forced to sell additional loans at sizable losses, negatively affecting earnings and eroding book value.

We don't believe the latter to be the case. Last week's unexpectedly strong jobs report and the widening of the yield curve show promise of strong recovery. Jamie Dimon has also voiced his opinion, saying that the economy looks like it's headed for a fairly rapid recovery.

The Bottom Line

The bottom line for investors is that revenue and earnings are likely to continue to suffer in the near term, as originations continue to slow, and charge-offs pile up. However, LendingClub's current valuation more than reflects that. Currently, the stock trades at 0.57x tangible book value. The market clearly is pricing in large losses in the future.

Data by YCharts

If you believe that the economy will continue to recover, LendingClub appears to be an attractive opportunity. No doubt that there are higher risks associated with the stock compared to other companies or financials in general. LendingClub's exposure is to high-yield unsecured consumer debt. However, the stock may be worth a deeper look for investors with a higher risk tolerance.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LC over 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.