LendingClub Corporation (NYSE:LC) Q2 2023 Earnings Call Transcript

LendingClub Corporation (NYSE:LC) Q2 2023 Earnings Call Transcript July 26, 2023

LendingClub Corporation beats earnings expectations. Reported EPS is $0.45, expectations were $0.04.

Operator: Hello, everyone. Thank you for attending today’s LendingClub’s Second Quarter Earnings Conference Call. My name is Sierra, and I will be your moderator for today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers around the end. [Operator Instructions] I would now like to pass the conference over to Artem Nalivayko, Vice President of Finance with LendingClub. Please proceed.

Artem Nalivayko: Thank you, and good afternoon. Welcome to LendingClub’s second quarter earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO, and Drew LaBenne, CFO. You can find the presentation accompanying our earnings release on the Investor Relations section of our website. On the call, in addition to the questions from analysts, we will also be answering some of the questions that were submitted for consideration via email. 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, our competitive advantages and strategy, macroeconomic conditions and outlook, platform volume, future products and services, and future business, loan and financial performance.

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 Form 10-K as filed with the SEC, as well as our subsequent filings made with the Securities and Exchange Commission, including our upcoming Form 10-Q. 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. Our remarks today also include non-GAAP measures relating to our performance, including tangible book value per common share and pre-provision net revenue. We believe these non-GAAP measures provide useful supplemental information.

You can find more information on our use of non-GAAP measures and a reconciliation to the most directly comparable GAAP measures in the presentation accompanying our earnings release. And now, I’d like to turn the call over to Scott.

Scott Sanborn: All right. Thanks, Artem. Welcome, everyone. We delivered solid results in the quarter, thanks to disciplined execution and by continuing to leverage the strategic advantages of our marketplace bank model. The quarter’s $2 billion in originations was in line with our guidance, reflecting planned lower balance sheet retention. Total revenue was $232 million and pre-provision net revenue, which is revenue less non-interest expenses, was $81 million, which was exceeding the high end of our guidance range and made possible by continued marketing and operating expense efficiencies. As a result, we delivered our ninth straight quarter of profitability. Now, let me provide some context on the current operating dynamic.

The bank portion of our business is demonstrating its resilience with net interest income stable quarter-over-quarter. However, we are facing, what we believe to be, temporary headwinds in the marketplace, which is resulting in pressure on our outlook for our non-interest income. First, as we signaled last quarter and as is evident in regional bank earnings reported thus far, banks are currently moving to the sidelines as they address their capital and liquidity concerns. And their pullback will have an impact on our near-term origination volume. And while we continue to have productive discussions with our bank partners, and though the appeal of our high-yield short-duration asset is more clear now than ever, bank’s capacity to invest is, for now, likely to remain restricted.

And second, to strengthen their capital position, banks are selling loan portfolios at deep discounts. That’s adding significant supply to a market that’s already saturated with investment options. On the positive side, asset managers are raising capital and they are stepping in to buy; however, they’re seeking higher yields to offset their higher cost of capital. And this is putting pressure on loan sales pricing. We don’t believe that this market dynamic is sustainable. And in the meantime, we’re leaning into our bank advantages to create new profitable structures to support marketplace volumes. I mentioned our structured loan certificate program last quarter, which is essentially a two-tier private securitization in which LendingClub retains the senior note and sells the residual certificate on a pool of loans to a marketplace buyer at a predetermined price.

This effectively provides low friction, low cost financing for the buyer, and in exchange LendingClub earns an attractive yield with remote credit risk and without upfront CECL provisioning. So as a bank, this is something we are uniquely positioned to deliver for our marketplace investors. We’ve had good initial reception to the program and we have a solid pipeline of forward interest. Another advantage of our bank is our ability to hold and season loans for investors, earning interest income for LendingClub while increasing the certainty around future credit performance for the buyer, which is especially important in this environment. We recently sold $200 million of seasoned loans at a gain, and we are receiving interest from investors to broaden the program.

I should also note that to deliver the returns required by loan investors in this rate environment, we are continuing to raise coupons. We’ve now priced in the majority of the Fed rate increases for near prime originations where we generally compete with non-bank lenders. Our pricing on our prime portfolio, where we generally compete with banks, is now up roughly 265 basis points. We’re being deliberate and disciplined here to avoid adverse selection, and we’re continuing to test our way up on pricing. Now let’s turn to credit, where our data advantaged from over $85 billion in loans, our flexible infrastructure, and our seasoned team has enabled us to continue delivering losses below the competition. And while we’re pleased with our credit outperformance and the strong returns we’re generating in our held for investment portfolio, delinquencies are modestly above our expectations on vintages booked before the prolonged inflation fully manifested and before we evolved our underwriting strategies and models.

The actions we have taken since then have resulted in consistent credit performance and we’ll continue to read the signals and adapt to maintain strong credit for loan investors and for ourselves. Looking ahead, federal student loan payments are set to resume this fall after a multiyear hiatus. And while we’re carefully preparing ourselves and our members for this new financial reality, we currently believe that any impacts to the portfolio will be muted, and that’s given a 12 month on-ramp period the government is providing, the many reduced payment options available, proactive credit actions we’ve taken to reduce exposure to what we believe are the higher risk segments of this population. Even so, we are taking additional steps to make sure our members stay on track, and that includes educational outreach to ensure that student loan debtors understand the size and timing of coming payments, they’re aware of the reduced payment options available to them from the government, and if needed, of custom hardship plans on their LendingClub loan if they need to bridge a gap.

As we demonstrated during COVID, a high touch proactive approach to helping our members can result in lower delinquency rates and increased loyalty. Our long-term ambition remains growing our member base and surrounding them with products and services that help them keep more of what they earn and earn more on what they save. We have continued to innovate, and starting over the next six months, we plan to test and launch an integrated mobile app that combines lending, spending and savings into a single experience; a debt monitoring and management tools fully integrated into this mobile experience, allowing members to easily view their debts, and prioritize and optimize their payments to reduce cost; and a pre-approved installment line of credit that allows existing members to seamlessly sweep any new credit balances into a loan at a fixed rate.

Importantly, this last feature will be built on a new revolving platform that will be able to eventually support additional new products. So, as I said earlier, the environment will continue to challenge our ability to drive meaningful growth for at least the remainder of 2023. But we do believe this period is temporary resulting from a confluence of macro events that won’t persist over the long term. And we remain prepared to accelerate when the environment stabilizes and we see the following: th`e Fed stops raising interest rates and, ideally, begins to lower them; banks have repositioned their capital and liquidity levels, enabling their return to the marketplace; and/or the current oversupply of investment options is subsided. As the partner of choice in this asset class, we expect to be a primary beneficiary of a return to more normal market conditions.

And we believe that we are well positioned to capture historic opportunity to refinance record high credit card balances at record high rates. Until that happens, we’re leveraging the benefits of our marketplace bank business model to maintain near-term profitability, bolster our long-term resiliency and create a more differentiated member experience. As always, I want to thank the LendingClub employees for their continued hard work and commitment to building towards our bigger future. And with that, I’ll turn it over to you, Drew.

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Drew LaBenne: Thanks, Scott, and hello, everyone. Let me walk you through the details of the results. I’ll start with originations in the second quarter. Originations were $2 billion compared to $2.3 billion in the prior quarter and $3.8 billion in the second quarter of 2022. Of the $2 billion in originations, marketplace sold loans were $1.4 billion, up $67 million compared to the previous quarter. As Scott mentioned, we’ve had early success in facilitating marketplace sales through the structured certificates. We issued approximately $180 million in the quarter, which helped drive growth in marketplace sales. Loan retention came back within our expected 30% to 40% range to $657 million, down from $1 billion in the first quarter as we normalized retention levels in line with our available earnings.

Now let’s move on to pre-provision net revenue, or PPNR. PPNR was $81 million for the quarter compared to $88 million in the prior quarter and $121 million in the second quarter of 2022. The outperformance compared to our guidance was driven by a $3 million revenue gain from a pending portfolio sale that was completed in early July, and a $6 million sequential improvement in expenses, primarily due to our previous streamlining of operations as well as proactive expense management in marketing and other areas. As Scott mentioned, we are seeing increasing investor demand for personal loans that have been seasoned, and we are originating a portfolio of approximately $250 million in loans for this purpose in the third quarter. These loans will come on the books at fair value with discount that approximates our observed whole loan sale prices.

Total revenue for the quarter was $232 million compared to $246 million in the prior quarter and $330 million in the same quarter of the prior year. Let’s dig into the two components of our revenue. You can find revenue details starting at Page 9 of our earnings presentation. First, net interest income was a $147 million, flat sequentially and up 26% over the prior year. Our net interest margin was 7.1% compared to 7.5% in the prior quarter and 8.5% in the prior year. The change was primarily due to higher average cash balances as well as increased cost of interest bearing deposits, which was partially offset by a higher yield on unsecured consumer loans. Marketplace revenue was $83 million in the quarter compared to $96 million in the prior quarter and $206 million in the same quarter of the prior year.

The change in marketplace revenue was primarily due to lower loan pricing, as well as a non-recurring $9 million benefit in the first quarter. Now, please turn to Page 13 of our earnings presentation where I’ll discuss expenses. Non-interest expense of $151 million in the quarter compared favorably to $157 million in the prior quarter and $209 million in the same quarter last year. The sequential reduction was primarily due to lower variable expenses in marketing and operations. Comp and benefits also improved as a result of slowing our pace of hiring across the company. Our expense run rate fully reflects the $30 million annual cost savings target we had communicated at the beginning of the year in which we are on track to exceed. Now let’s turn to provision.

Provision for credit losses was $67 million for the quarter compared to $71 million in both the prior quarter and the second quarter of 2022. The sequential decrease was primarily the result of lower day one CECL due to fewer loans retained in the quarter, partially offset by more accretion on a larger back book of loans and an increase in reserves on the 2021 and 2022 vintage. As you will see on Page 15 of our earnings presentation, we have modestly increased our range of estimates for the expected net lifetime loss rates on the 2021 and 2022 vintage, which reflects the impacts of inflationary pressure on borrowers. While it’s still early to judge the ultimate performance of the 2023 vintage, our initial observations are that it is now showing stable performance, benefiting from the tightened underwriting we’ve implemented over the last several quarters.

On Page 16, we have updated our marginal return on equity on personal loans to a range of 25% to 30% to reflect a lower net interest margin due to higher funding costs and higher quality mix. In addition, we thought it would be helpful to share the marginal returns on our structured certificates, which generated a marginal ROE of approximately 20% and using our current balance sheet leverage. It is also important to note that the risk weighting on these securities is 20%, which means that these returns are even more attractive on a risk-adjusted basis. Now, let’s move to taxes. Taxes in the quarter were $4.7 million, or 32% of pre-tax income. As I mentioned in the last quarter, we will have some variability in the effective rate from quarter to quarter.

Our effective tax rate is 27% year-to-date, and we continue to expect that to be in line with our long-term tax rate. Now, let me touch on the balance sheet. Few things to note here. Total assets were $8.3 billion for the quarter compared to $8.8 billion at the end of the previous quarter. The decrease was primarily due to lower cash balances as a result of the planned maturity of brokered deposits. Our securities portfolio grew to $524 million in the quarter. The increase of $143 million primarily reflects growth in our structured certificate program. As I mentioned earlier, we retained the senior tranche of the security and hold it on our balance sheet. In addition to the senior tranche, we also hold a 5% whole loan security as required by Dodd Frank.

You will see the securities portfolio continuing to grow as the program scales. Loans held for sale at fair value were $250 million at the end of the quarter as we moved approximately $200 million in held for investment loans into held for sale for the transaction that was completed in early July, which I spoke to earlier. As I mentioned, we are seeing increased demand for these types of seasoned loans. We are planning on growing this program and completing more transactions in the future. Our consolidated capital levels remained strong with 12.4% Tier 1 leverage and 16.1% CET1. Our available liquidity remains healthy with $1.2 billion of cash on hand and 85% of our deposits are insured. Additionally, we continue to maintain substantial amounts of unused borrowing capacity at both the Federal Home Loan Bank and Federal Reserve Bank, with a total of approximately $4 billion at June 30.

Now let’s move to our guidance for the third quarter. As Scott mentioned, we expect bank demand to be constricted with marketplace volume going primarily to asset managers at lower prices. This is informing our outlook. For the third quarter, we expect originations between $1.4 billion and $1.7 billion. And we expect PPNR to range from $40 million to $50 million, which includes up to $10 million of one-time benefit related to recouping volume-based purchase incentives from the bank investor channel. It is our objective to remain profitable for the quarter on a GAAP basis by continuing to execute with discipline on expenses, and reducing our held for investment loan retention. Our guidance for the quarter assumes 30% to 40% balance sheet retention, which includes both held for investment and held for sale originations.

Putting it all together, we are planning to maintain the size of our balance sheet in third quarter through a combination of held for investment whole loans, growing the structured certificates program, and held for sale extended seasoning. Held for investment loans will reflect the upfront CECL provisioning of structured certificates, and held for sale loans will be under fair value accounting. We continue to diversify our balance sheet through these new structures and programs, which will enable us to earn attractive recurring revenue via interest income while also helping to facilitate marketplace sales. We believe that a recovery in the marketplace will take longer than initially expected given the continued pressure on banks and aggressively priced secondary loan sales.

While we’re not giving fourth quarter guidance at this time, we expect these pressures to continue at least for the remainder of the year. But regardless of the market conditions, we have a resilient business, and we will remain focused on profitability versus growth. As we look further ahead, there’s a massive opportunity in front of us. We are well positioned to accelerate quickly as conditions improve. In the meantime, we will continue to execute with discipline, innovate on our offerings, and leverage our strategic advantages as a bank to evolve the marketplace. With that, we’ll open it up for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Bill Ryan with Seaport Research Partners. Please proceed.

Bill Ryan: Good afternoon. Thanks for taking my questions. First question is just on your origination volume. I mean, kind of looking at it, you’re within guidance this last quarter. And looking at it year-over-year, it just seems like you’re either tightening up on credit again right now because the volume of — range that you’re giving relative to a year ago, looks like it’s going to be a little bit softer on a year-over-year comp basis, or are you just kind of originating based on what you see the investor demand is right now and then what you can put on the balance sheet?

Scott Sanborn: Hey, Bill. This is Scott. Yes, it’s really the latter, which is basically with the impact of bank purchases. As we mentioned in the prepared remarks, it’s really — we’re originating for the available investor demand economics that we find acceptable. So, we’re — it’s not a credit story. We are, of course, continuing as always to manage credit, but origination volumes are really targeted to demand at the prices that we’re willing to take.

Bill Ryan: Okay. And a follow-up question just on the NIM. We…

Scott Sanborn: And I’m sorry, Bill. Just…

Bill Ryan: Yes.

Scott Sanborn: Just stating the obvious, the TAM right now is enormous. I mean, we touched on it in the remarks, but, credit card interest rates have moved up yet again. They’re currently at 20.7%, the highest they’ve ever been and it’s over $1 trillion in assets there. So, we are — this is not about borrower demand.

Bill Ryan: Okay. And just to follow-up on the NIM outlook. You guided last quarter that it would be down talking about the structured certificates buildup of liquidity on the balance sheet. Sort of looking forward, are we getting close to a bottom here, or do you see potentially a little bit further margin compression from here?

Drew LaBenne: Hey, Bill. It’s Drew. First of all, exactly correct on the decrease from Q1 — in NIM from Q1 and Q2, about half of that decrease was the buildup in cash. Going forward, we’ll continue to have, I think, more modest pressure on NIM downward for a quarter or two, but I would say it does depend on, if the Fed does anything else in the future and kind of the competitive nature of the deposit market and if that evolves in any way. But I think we’re — if those two things remain stable, then I think we’re close to the bottom on NIM, little bit further to go.

Bill Ryan: Okay. Thanks.

Operator: Our next question comes from Reggie Smith with JPMorgan. Please proceed.

Reggie Smith: Good evening, and thanks for taking the question. I guess a follow-up to Bill’s question earlier. So, it sounds like, like you said, the volume or rather the demand for loans is still high. And just kind of looking across the landscape, it feels as though most personal loan issuers are kind of pulling back now. So my question is, with that dynamic, why aren’t you able or maybe you are able to charge more either APR or origination fee? Like, what’s the sensitivity? Because it would seem that with a smaller origination basis, you could probably squeeze in pricing out. What am I missing there?

Scott Sanborn: Yeah. Hey, Reggie. So, I’ll try to touch on this. It really depends on what segment of the market you’re talking about. So, in, let’s call it, the near prime portion of the portfolio where the competition is non-bank lenders, that includes fintech, but also specialty finance companies, whose cost of funds is moving and locked up with the forward curve, we are able to pass the price on, and indeed, we’ve done that already. So, the pricing on our near prime portfolio that we’re — we don’t hold that, but the stuff we’re issuing is actually pretty close to the amount that the Fed has already moved. But in the prime space, we’ve moved up credit quality, given the environment we’re in. And given the outlook, we’ve moved most of our origination upmarket, both for what we hold, but also what we sell, because that’s where the investor interest is highest right now.