LendingClub Corporation (NYSE:LC) Q4 2022 Earnings Call Transcript

LendingClub Corporation (NYSE:LC) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Good afternoon. Thank you for attending today’s LendingClub Fourth Quarter 2022 Earnings Conference Call. My name is Megan and I will be your moderator for today’s call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host Sameer Gulati with LendingClub. Please go ahead.

Sameer Gulati: Thank you, and good afternoon. Welcome to LendingClub’s fourth quarter and full year 2022 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 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 Forms 10-K and 10-Q is filed with the SEC, as well as our subsequent filings made with the Securities and Exchange Commission, including our upcoming Form 10-K. 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 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, Sameer. Welcome everyone. We closed out 2022 with solid results. Both revenue and earnings were near the high end of our guidance range, and importantly, we took action to position the company well to navigate current headwinds. The power of our evolving model is evident in our numbers. Our growing stream of net interest income offset the anticipated decline in marketplace revenue and enabled us to deliver total revenue in line with fourth quarter of 2021 despite a decline in loan originations. For the full year, we generated 45% revenue growth and a record $290 million in net income, or $146 million after you exclude tax benefits from the release of our valuation allowance. We invested our strong marketplace earnings back into our balance sheet, doubling the size of our held for investment loan portfolio, which allowed us to more than double our net interest income.

These results begin to provide a sense of the power of this business over the long-term. Our goal, when the environment stabilizes, is to continue to grow the bank balance sheet and the corresponding interest income revenue stream with marketplace revenue acting as a capital-light earnings complement, as well as a compelling membership growth driver. To reach this destination, we first need to navigate through the current environment, and we have plans to do just that. While it’s unclear where exactly the Fed and the U.S. economy would land, we remain focused on what we can control and are positioning ourselves to best manage through the uncertainty. Our focus is on three key areas. One, continuing to prudently manage credit quality through the cycle; two, preserving profitability and maintaining a strong balance sheet; and three, being practical and focused in our product and technology investments.

So starting with credit, where we will remain laser focused on managing credit risk for both our marketplace investors and ourselves. I’d note the loans we hold on our balance sheet representing prime and high prime customers are continuing to perform well as you’ll see on Pages 16 and 17 in our presentation. For loans sold through the marketplace, we are pursuing quality over quantity. As we have spoken about for several quarters, the rate environment is putting pressure on marketplace volumes as the relative value we can provide is compressed until we can reprice our loans to reflect the dramatic increase in cost of funds for especially our non-bank investors. In this higher rate lower volume environment, we have both the responsibility and the opportunity to be selective on credit.

Our delinquencies have outperformed industry averages, but we need to remain vigilant and proactive. We anticipated and have seen pressure on our members, most notably in near prime and especially among those consumers with lower incomes. We are also seeing a dynamic pace of change in areas like savings rates and prepayment speeds. A core strength for LendingClub is our ability to use our data advantage and our technology infrastructure to quickly adapt to emerging signals. Accordingly, we were proactive to begin tightening early in 2022 and have continued to tighten our underwriting throughout the year. For reference, our fourth quarter near-prime volumes are down more than 50% from their peak. Longer term, the opportunity to grow personal loans remains significant.

With credit card balances building at an over 20% average APR, even more consumers will benefit by refinancing their high-cost credit card debt into a fixed-rate installment loan. And as interest rates stabilize and the U.S. economy regains its footing, we expect our marketplace volumes to rebound. Our second key objective is to maintain profitability and a strong balance sheet. We recently announced the difficult decision to streamline our operations to better align our expense base to our outlook. We also bolstered our net interest income by acquiring a large portfolio of seasoned, high-quality loans from one of our marketplace investors. In the near term, we expect marketplace revenue to be under pressure until the Fed slows or ideally stops with rate hikes.

At the same time, we plan to maintain a stable interest income revenue stream by keeping the balance sheet at roughly its current size. Our final area of focus is to continue to prudently invest in the core product and technology capabilities that will create more value for our 4.5 million members. While we remain committed to our long-term vision, we are slowing down the pace of our investments. And our intent in 2023 is to put the building blocks in place that will support future growth opportunities as we come out of the current environment. Certainly, we will remain mindful of the macro economy and we’ll continue to adjust the pace of our investment as needed. So I’m going to turn it over to Drew now to walk you through the detailed financial results and our outlook.

Drew LaBenne: Thanks, Scott. And hello everyone. Let me take you through our financials in greater detail, starting with the originations and our balance sheet. Originations for the quarter were $2.5 billion, compared to $3.1 billion in the prior year and $3.5 billion in the third quarter of 2022. As Scott discussed earlier, originations were impacted by a combination of higher interest rates curtailing investor demand for loan purchases and our continued discipline in underwriting to maintain strong credit quality. As we deploy capital to retain more of our highly profitable personal loans, we showed significant growth in the balance sheet compared to the previous quarter and over the course of 2022. Total assets increased 63% year-over-year to $8 billion in Q4, with our held-for-investment loan portfolio up 104% over the same period, primarily due to growth in personal loans.

Photo by Amy Hirschi on Unsplash

We also grew deposits 104% year-over-year now that we have scaled the online banking platform that we acquired. Since the closing of the Radius acquisition in the first quarter of 2021, we have grown the bank from $2.7 billion in assets to $7.6 billion in assets, which is a compounded annual growth rate of over 70% and firmly highlights the benefits of bringing LendingClub’s strength of loan originations together with the digital banking model. Earlier, Scott mentioned the portfolio we acquired in December. We are accounting for the portfolio under the fair value option as the short remaining duration in high credit quality limit volatility around its expected performance. We expect this portfolio to generate very attractive returns and have broken it out separately in the net interest margin table in our earnings materials.

Now on to revenue. Total revenue was essentially flat year-over-year as net interest income growth of 63% was offset by a 29% decline in non-interest income. Revenue decreased sequentially by $42 million, reflecting lower originations sold through the marketplace and the price on those sales. Our decision to increase loan retention in 2022 has enhanced the resiliency of our franchise during a more difficult environment for the marketplace. Net interest margin increased to 7.8% from 7.6% in the prior year period due to an increase in the proportion of higher yielding consumer loans on the balance sheet. As expected, we saw a sequential drop from 8.3% in the third quarter of 2022, primarily due to the current lag between our ability to pass along higher interest rates on new personal loans relative to the repricing of online deposits.

We expect the net interest margin to decline again in the first quarter of 2023 as these trends continue and for the pressure to abate should the Fed’s slow rate increases or stop them all together. Total net interest expense for the quarter improved $8 million compared to the same quarter in 2021 and was a reduction of $6 million from the previous quarter. Compensation and benefits expense included $4.4 million in severance charges from the previously announced expense reduction plan. Marketing efficiency was better than expected given the use of more efficient channels and lower competitive pressure. Marketing expenses improved by $11 million compared to the third quarter, primarily reflecting lower origination volumes. Our consolidated efficiency ratio moved to 68.5% from 61% in the third quarter as revenues decreased sequentially.

As Scott discussed, the reduction in staff was a difficult decision, but necessary given the more challenging near-term outlook. The reductions will generate $25 million to $30 million of annual run rate savings and compensation and benefits. These savings came primarily from an improved efficiency in our management structure, the slowdown in some strategic initiatives and ceasing originations in two commercial businesses, commercial real estate and equipment finance that we acquired from Radius. We will take the remaining severance charge of $1.3 million in the first quarter. Slide 15 shows the pre-provision net revenue, or PPNR, and the net income for the quarter along with other metrics. In 2023, we will move to PPNR as the key metric, which provides a better gauge on income statement performance.

PPNR is a useful measure for evaluating the underlying performance of our company without the quarterly volatility caused by credit loss provisioning. For the fourth quarter, we had PPNR of $82.7 million which increased 12% compared to the same quarter in 2021. We remain pleased with the performance of credit in our portfolio. Our provision for credit losses was $62 million, $21 million lower than the previous quarter, primarily due to a decrease in the dollar amount of loan originations held on balance sheet. Our allowance coverage ratio, excluding PPP loans, increased to 6.6% from 6.4% in the previous quarter due to the effect of ongoing recognition of provision expense for discounted lifetime losses at origination. In the fourth quarter, our tax rate again benefited from a reversal of our remaining valuation allowance as well as R&D tax credits.

For the quarter, we had a tax benefit of $2.4 million. As we enter 2023, we expect less volatility in taxes, and the tax rate is expected to be approximately 28%, but other factors such as share price movement will continue to impact our reported tax rate going forward on a quarter-to-quarter basis. Tangible book value per common share grew 35% year-over-year to $10.06 per share at the end of the fourth quarter. We have maintained strong capital ratios on top of a significant allowance for credit losses. This positions us to better navigate through the current environment and provide the ability to strategically deploy capital as opportunities arise. Now please turn to Page 16, where we have provided you with an update to the 30-plus day delinquencies of our prime personal loan servicing portfolio as well as our held-for-investment personal loan portfolio.

You will see that credit quality in the prime servicing portfolio continues to normalize as the portfolio seasons and new origination growth slows in the marketplace. The same effect is also true of our own HFI portfolio. We expect this trend will continue given the lower level of originations in the near-term. Given that changing growth trends and seasoning are creating comparability issues with historical data, we are not planning to provide this slide in the future. On the next page, we have provided more detailed disclosure on our loss expectations, which we believe provides a cleaner view of performance. So on Slide 17, you can see credit performance of personal loans on our balance sheet by vintage. We expect the lifetime loss of the 2021 and 2022 vintages to be up to 8% and 8.7% respectively.

The estimate for both vintages includes qualitative provisions for the uncertain economic environment. The 2021 vintage delivered very strong credit performance given the effect of government stimulus during the pandemic. The 2022 vintage reflects a move to a higher quality mix of credit but also a normalization of credit trends. We expect annualized net credit losses to be approximately 5% over the life of the 2022 vintage, but that could vary if economic conditions deteriorate significantly. For each vintage, we are providing the breakout of how much in charge-offs have been realized as of the end of 2022, how much of future losses have already been reserved for in our allowance for credit losses, and how much remaining provision we estimate we will take through the income statement, which mainly represents the Day 1 CECL discounting coming through the provision expense over time.

If we look at the net interest margin factor in variable expenses and annualized credit losses, we expect post-tax levered returns in the low to mid-30% range. These returns are the reason we plan to invest our available earnings and growing the balance sheet. Now let’s move to guidance and how we’re thinking about 2023. Given the broader macroeconomic uncertainty, we are moving to quarterly guidance. For the first quarter, our origination outlook is $1.9 billion to $2.2 billion, reflecting prudent underwriting and the rate-driven pressure on marketplace demand. We plan to maintain the size of our HFI balance sheet. Therefore, we expect to retain 30% to 40% of our loan originations for the quarter. For marketplace originations we sell, we expect unit economics in line with the fourth quarter.

We plan to maintain positive net income levels and invest in-period earnings into loan retention to support future earnings. As we reinvest our capital, we will maintain a disciplined approach to underwriting, drive credit performance and required returns. In 2023, we want to maintain flexibility to grow the balance sheet when we generate excess earnings available for investment. The impact of the Day 1 CECL charge on loan retention can have a significant impact on earnings. With this in mind, we have evolved our focus to pre-provision net revenue, which is a more relevant guidance metric for financial services companies using CECL accounting. Our outlook using PPNR is $55 million to $70 million for the first quarter. With that, let me turn it back to Scott for closing comments.

Scott Sanborn: Thank you, Drew. Clearly, the multiple economic variables that are at play here have affected our near-term outlook, but I do believe we’ve positioned the company well and that we have strategic and structural advantages that will help us outperform over time. As we finish off the year, I just wanted to take a step back to recap the progress we’ve made since we acquired the bank. In two years, we have completely transformed the financial profile of the business. We’ve more than doubled the balance sheet, cut tens of millions in issuance costs, added a new recurring revenue stream that represents almost half of our quarterly revenue, and we’ve significantly grown our equity. These strong fundamentals will help us manage through what will ultimately be temporary headwinds.

As interest rates stabilize and credit card balances and APRs remain at or near-record highs, we believe that our core business of credit card refinancing will be well-positioned to quickly resume growth and drive marketplace revenue. With that, I wanted to say a sincere thanks to all of my fellow LendingClubbers, both those who are with us today and those who we recently had to say goodbye to, for their contributions to our company and to our customers. That’s it. Thanks again for your time, and I’ll open it up for questions.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Bill Ryan with Seaport Research. Your line is now open.

Bill Ryan: Thanks for taking my question. Starting with kind of the guidance, I was looking at it, you have PPNR of $55 million to $70 million, and you look at it with your originations of $1.9 billion to $2.2 billion. You take a midpoint. Your reserve on the consumer portfolio was, I believe, a provision was 8.8% of retained originations. So assuming that math, it looks like you might be breakeven, plus or minus in Q1. So is the 8.8% correct? Is that kind of a good number to use? Or was there something incremental in the provision? And kind of tying with that, the expenses, the charge that you took to reduce the fixed cost and then you’ve got a 50% variable cost structure. How long before the cost reduction start to kick in? Is there any of it really in the Q1 guidance? Or does that kind of roll €“ spill over more into Q2?

Drew LaBenne: Yes. Great. Thanks Bill for the question. So let me start with the provision question first. So you’re correct on that ratio. Keep in mind that the components that go into the provision are the day one CECL. The accretion of the discount we have on day one and then other qualitative factors as well. And so one thing about that accretion of the discount is, it really hits more heavily in the first and second quarter after origination. So if you look back at our origination trends, this quarter had a higher amount of that back book accretion coming in. As we look forward to Q1, I don’t want to talk about the ratio as much, but if you think about it in terms of dollar amounts, we’re remixing to higher quality credit.

We should probably have less accretion just because of the recent trends in originations. And so right now, we would expect that provision to actually come down quarter-over-quarter. But obviously as I just said, it’s a very volatile measure. So there are a lot of different outcomes that are possible on the provision line in any given quarter. Second on expenses, so on the 50% variable cost market

Scott Sanborn: Sorry, just one other thing to add, Bill, is the other important part of the message we want to make sure you hear is, our intention is to maintain the balance sheet given the details we’ve shared on the attractiveness of the loans we’re plan to continue to add. To the extent that we’ve got available earnings, we would put those into the balance sheet. That’s one of the other reasons why we’re not guiding to that. There’s both the volatility of the provision and also just the intent to be able to continue to grow the balance sheet should the earnings permit it.

Drew LaBenne: Yes. And in Q1, we €“ I should have added just back on the provision as well. In Q1, as we’re going to higher quality loans, we expect that sort of the upfront charge will be lower on the higher quality loans that we’re putting on the balance sheet, which also benefits the provision. On expenses, the vast majority of the savings that €“ annualized savings that we reported are fixed cost, there is some portion less than 10%, which is variable cost of that reduction. But then the biggest reduction you’ll see in our variable cost base as originations comes down is marketing. And you’ve obviously already seen that come down each quarter as originations have also declined,

Bill Ryan: But as in terms of timing, both of those expenses come through?