LendingClub Could Increase Operating Income At Least 5x By FY24

Summary

• LendingClub pivoted to a hybrid lending model since it acquired Radius Bank in 2020.
• Its pivot presents superior unit economics and a more flexible business model that can handle macroeconomic headwinds better.
• Despite its 300%+ YTD price appreciation, it has more upside potential.

Michael Vi/iStock Editorial via Getty Images

Investment Thesis

Since acquiring Radius Bank and becoming a bank holding company, LendingClub (NYSE:LC) pivoted its business model from a pure P2P lender to a hybrid one that leverages its combined strengths in both digital lending marketplace and superior unit economics in a capacity as a bank to retain loans.

While re-rating has taken place multiple times since early 2021 and presents a stunning 300%+ YTD performance, I present my case that if LC continues to execute its current strategy, it could grow to $7-8B loan book (unsecured consumer loans) by early 2024 with about $700mil LTM operating income.

Data by YCharts

I believe $700Mil annual operating income more than justify today's valuation of $4.7B. In the meantime, it also offers promising optionalities in auto-loan and BNPL segments, which will be discussed in a later chapter.

History

LendingClub, founded in 2006, was a pioneer in the P2P lending landscape.

While most credit unions/banks only used FICO scores for unsecured consumer loans, LendingClub was one of the first who provides over 100+ borrowers' factors (data points) for the marketplace lenders to make lending decisions.

Over the last 15 years, LendingClub originated $68B loans and serviced over 3.8 million customers, and is one of the largest players in the unsecured consumer loan space.

While LC's reputation was tainted by its CEO resignation in 2016 after an internal probe revealed Mr. Laplanche's misconduct in selling $20+Million faulty loans to investors.

It also struggled with the p2p lending business model when borrowers' need arises (often due to macroeconomic headwinds), liquidity (from lenders) often shrinks.

In Feb2021, it acquired Radius and became a bank holding company.

Business Model

Acquisition of Radius Bank allows LendingClub to fundamentally change its business model which improves both unit economics and offers flexibility to bridge potential gaps between supply and demands.

It originates loans through its lending club marketplace ($3.1B 3Q21). It retains between 15-25% (it kept ~20% in 3Q21) on its loan book and sells the rest to institutional clients (aka marketplace).

I divide the LendingClub business into 2 segments.

Its marketplace segment generates revenue from selling and servicing loans sold in the marketplace.

Its retained loan segment generates revenue like any traditional bank operation via Net Interest Margin between loan and deposit.

From its last 2 quarter reports, I find its marketplace Revenue, by and large, covers its operating expense, and its operating income is pretty much equivalent to income from its retained loan segment.

Unit Economics

Marketplace Revenue: it includes loan origination fees sold to institutional clients, and servicing fees/gain on sales of the loans sold/managed in the marketplace.

Origination and Sales fee ~= 5% total origination volume, servicing fee each quarter is ~0.25% (1% annually) total principal balance of loans (currently ~10B).

with $3B origination in 3Q21, and a total of ~$10B principal balance of loans, its marketplace revenue was ~$180M.

3Q21 total operating expense is ~180M.

Retained Loan Revenue: Loans include secured consumer, commercial, unsecured consumer, and PPP loans), with interest rates ranging from 4% to 16%. The average deposit cost is 0.3%.

The table below provides loan breakdowns by category.

Source: LendingClub 3Q21 Earning results

Here is what gets interesting: LC projects loans origination between 10.1B to 10.3B in FY21 ($3.1B in 3Q21), and retain 15%-25% (20% in 2Q21).

LC kicked off this hybrid strategy in 1Q21, at this speed, it will increase its total unsecured loan at ~$2-2.5B each year. As the average loan duration is 3 years, its unsecured loan book will grow to its full capacity by early 2024, with a total of $6-7.5B unsecured loans in the book.

In other words, if LC can continue to execute the above strategy, its operating income will increase at a rapid pace along with its loan book growth, till 2Q24, reach near $700Mil operating income LTM.

For these interested, the detailed 3Y income/expense projection is included in the excel model (valuation chapter below).

Valuation

Base-case scenario: LC continues to execute the current strategy and build its retained loan book to full capacity in 3 years, with similar unit economics as it presents today.

Under that scenario, by 1Q FY24, its LTM Operating Income would be $680M, a stunning turnaround story considering its FY21 Net Income is projected between 9-14M. If we use 12x MCap/Operating Income multiple, with a 15% discount to NPV, that would value it to ~$7B ($70/share), presenting a ~45% upside potential to its current price.

Model assumption:

1. Unsecured consumer loan market TAM remains flat (~85-90B).
2. LC maintains the same market share of $10-12B loan origination/year
3. Unsecured consumer loan net interest rate between 15% to 16%
4. 6% CECL provision represents the fair charge-off projection (currently at 5.25%)
5. The deposit interest rate remains at 0.3%

How sustainable is the projected growth?

3 key factors to support sustainable growth are Loan origination, funding, and performance. As I laid out in my analysis below ample evidence of sustainability in all 3 factors.

Loan Origination Sustainability: Unsecured consumer loan has a TAM at roughly $80-90B each year. LendingClub is a top player in the field at a 12-13% market share.

in 2Q21, its marketing expense is ~160 basis points of origination, which is one of the best in the industry. It demonstrates its brand power, supported by its large customers base (>3.8 million customers).

As a comparison, in their latest sec filings (2Q21), Upstart (UPST) spent $75M on marketing expense for $2.8B processed loan, 268 basis points (100 bps higher than LC), and OppLoans (OPFI) spent $11.5M on marketing for $144M processed loan, 799 basis points.

LC historically spent between 190-200 bps in marketing and in the 3Q21 conference call, management expressed their willingness to increase marketing expense if justified.

Funding sustainability: Incremental unsecured loan funding ($500-600M a quarter) comes from:

a) Additional bank deposit (~150M in 3Q21)

b) Positive cash flow (increase at a rapid pace from currently ~80M this quarter to projected $250M in 1Q24)

c) Retirement of existing secured loan (retired ~$180M/3Q21)

Loan Performance Sustainability: LendingClub mostly targets near-prime borrowers with interest rates ranging from 7% to 36%. Its advantage is its collections of large data points for each loan/borrower including $60B+ loans, 3.8 million+ customers accumulated over the last 15years. Here is a recent slide showing its low loan delinquency rate compared to the industry.

Source: LC 3Q21 earning presentation

Optionality

Auto loan refinancing: Scott Sanborn during 3Q21 CC talked about its 85% QoQ growth in auto refinance, and why LC is well-positioned to compete in the space (emphasis added):

One example of this is auto loan refinancing. Nearly 2/3 of our members currently hold an auto loan, and it's usually their second highest monthly debt outside of housing costs. Given the structural inefficiencies in the used car market, we can efficiently utilize our data and technology to offer customers a better rate in just a few minutes. We typically reduce the APR for our members by more than 5% and which translates into thousands of dollars of savings over the life of a loan. We've built a great product but have been disciplined about the investment and growth rate of the auto business.

During our incubation period, we've been focused on 2 objectives: one, building an incredible customer experience; and two, demonstrating a track record of performance. Now with the added funding benefit of our bank, we're able to generate positive unit economics. And in Q3, we drove 85% quarter-over-quarter growth in auto refinance originations. Our current focus is on our members, the $300 billion broader addressable market for auto refinance, does provide us with a substantial long-term opportunities.

Buy Now Pay Later: CEO Scott Sanborn during 3Q21 CC talked about BNPL

Next up is our Buy Now, Pay Later purchase finance business which is designed for planned large ticket purchases in elective medical, dental and education. We've been in this business for several years through issuing bank partnerships and are now deploying our banking capabilities to issue these loans and take better advantage of our personal loans infrastructure. This will allow us to not only capture more of the value chain economics but also significantly improve the member experience. I'll plan to talk more about this business next quarter.

Both are exciting optionalities. Auto loans will expand from the current $80-90B unsecured loan TAM to a much larger auto loan space (TAM > $1T), and BNPL is the most vibrant/disrupting FinTech sector with firms such as Affirm (AFRM) valued at north of 40x P/S.

I call both optionalities as I need to see more concrete data/strategy to include either one into my valuation model. For now, I consider both a pie in the sky show-me story. (the auto loan 85% QoQ growth is impressive, but with no breakdown numbers, I assume it was a super easy comp)

Items to Monitor

In the coming quarters, I will monitor the items below to continue to evaluate my thesis:

1. Loan origination at $2.5B to $3B each quarter, at a comparable marketing expense / originated loans (currently at ~150bps)
2. With sufficient low-cost funding (~0.3% in 3Q21) to retain ~20% loans ($500-600M) to its book
3. Monitor CECL provision (5.25% in 3Q21) and charge-off as loans mature.
4. Further updates/development on BNPL and auto loan refinance

Conclusion

I project LC earns ~$700M operating income in FY24, a modest 12x MCap/OpIncome values LC at ~$7B ($70/share), a ~45% upside potential to its current price.

Further upside could be unlocked if material progress is made in Auto Loan or Buy Now Pay Later segments.

P.S. Special thanks to IP Banking Research for bringing this hidden gem to my radar and his subsequent high-quality follow-up analysis.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LC either through stock ownership, options, or other derivatives. 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.