What happened

Shares of LendingClub Corp. (NYSE:LC) are down about 20% as of 11 a.m. EST Wednesday after the company said it was tightening credit standards. The company reduced guidance for the remainder of the year to account for lower origination volume.

So what

Compare LendingClub's full-year guidance it gave in August to the guidance it gave in November and you'll see a marked change in fourth-quarter expectations for revenue and adjusted EBITDA.


Full-Year Guidance in August

Implied Guidance in November

Total net revenue

$585 million to $600 million

$576 million to $581 million

Net income (loss)

($69 million) to ($61 million)

($69 million) to ($65 million)

Adjusted EBITDA

$50 million to $58 million

$44.5 million to $48.5 million

Data source: LendingClub, SEC filings. Calculations by author for implied November guidance.

LendingClub said that it reduced its outlook for the rest of the year due to the implementation of a new credit model, which would result in lower origination. In his prepared remarks on the third-quarter conference call, LendingClub's CEO, Scott Sanborn, said, "In our prime portfolio, this new model does represent a tightening, with an overall shift to higher-quality grades and higher-quality approvals within grades."

Money going down the drain

Making loans is easy. Getting paid back is the hard part. Image source: Getty Images.

Competition may be partially to blame for weak loan performance in certain parts of the credit spectrum. Later on the call, LendingClub's chief financial officer, Thomas Casey, said that "as you see more and more players provide options for consumers, those consumers that are on the edge that are -- have lots of options, they are seeing more and more presented alternatives. And so they're taking advantage of that and, in certain cases, increasing their debt loads to a level that is challenging."

Casey later added, "We're going to test those F and G type of credit categories to potentially underwrite them in a different way with some different features to see if we can improve the performance of those loans."

Now what

LendingClub's credit tightening is in response to some poorly performing cohorts. Notably, of loans issued in 2016, loans issued to F- and G-rated borrowers (the riskiest borrowers) have generated a negative adjusted annualized return due to outsize loan losses, despite the fact these loans carry an average interest rate of 26.5%.

E-rated borrowers aren't doing much better, generating adjusted net annualized returns of 1.95% for investors, despite an average interest rate of 22.45% on loans in the 2016 cohort. LendingClub discloses its loan pools' performance on its website.

Low or negative returns aren't exactly LendingClub's problem in the sense that it makes its money by selling loans to investors, collecting ongoing servicing fees thereafter. However, LendingClub's originations have to produce an adequate return for investors, to keep them coming back for more.

To that end, LendingClub's decision to implement a new credit model earlier than anticipated suggests that the company was running a little too hot, approving too many borrowers who wouldn't repay in full, raising questions about whether it can grow quickly and do so without sacrificing loan performance.

Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.