It's been a difficult six years for LendingClub (LC 2.45%) as a public company. After coming to market in late 2014 as a new-age fintech platform at a $5.4 billion valuation, the company has since plunged to just a fraction of that, with a current market cap of only $850 million.
So, what happened to LendingClub? Things started going wrong in 2016, when former management was caught violating company business practices matching loans with buyers in order to move more more loans through its platform. LendingClub had set itself up as a peer-to-peer lender, with retail investors buying high-yield loans from borrowers. LendingCLub acted as a scaled "marketplace," offering investors diversified pools of parts of loans, while borrowers could get personal loans at lower rates than credit cards, since LendngClub didn't have any brick-and-mortar infrastructure.
The thing was, LendingClub was dependent on volume, and it seems the founder cut corners in pursuing growth. Not only that, but LendingClub's loans started to experience increased chargeoffs in 2016 as the economy slowed.
The stock has never recovered from the fallout, as the company was caught up in costly lawsuits and a business model retrenching ever since. New CEO Scott Sanborn has been transforming the business over the past few years, which may have soured the original investors in LendingClub, without attracting more traditional financial stock investors.
However, I think better days are ahead for LendingClub, which just closed a potentially transformative acquisition just on February 1 and could be on the brink of a big turnaround.
LendingClub was turning the corner prior to COVID
Things were actually looking pretty positive for LendingClub and its turnaround just before COVID hit. After the 2016 scandal, LendingClub slowed originations, and aimed more at prime borrowers with tightened underwriting. In addition, LendingClub sought out more stable institutional investors, such as banks, insurance companies, and other professional funds. This has helped stabilized the funding side of the platform, as these institutions are fine with lower yields in exchange for safer investments. They are also much less "flighty" than individual retail investors lured in by high yields. And the company has also innovated more products, including liquid, tradable securities made up of LendingClub loans on several different platforms, opening its loans up to more types of investors.
That slowed down LendingClub's growth, but was likely necessary. Any company involved in lending is always tempted to boost growth in the near-term, but making too many bad loans can come back to bite you in the long-term, as LendingClub painfully learned.
Still, LendingClub did, prudently and methodically, increase originations between 2017 and 2019, from $9 billion in originations in 2017 to $12.3 billion in 2019. Margins also increased, due to both scale and management efforts to cut costs. The company even reach adjusted net income profitability for the first time in years in the third quarter of 2019. Even after it slowed down originations, LendingClub was still the largest originator of personal loans in the U.S.
Covid-19 cons and pros
For sure, the COVID-19 downturn wasn't great for any financial company. At the onset of the pandemic, the company immediately pulled back on lending, cutting originations by 87% quarter-over-quarter in Q2, then slowly increasing in Q3, with another expected increase in Q4. Still, originations and revenues will still be down a lot from the prior year. Obviously, LendingClub's adjusted net margins went negative this year once again.
However, there are some silver linings. The company has continued to cut costs, and its loans made pre-pandemic are holding up well. LendingClub expects that pre-COVID loan vintages are still averaging 4% returns, which is not too far below their original expected return. And post-COVID loans are forecast to return between 5%-6%. Investors are also returning to the platform after a justified hiatus after COVID broke out, increasing loan buys in Q3 and Q4.
One of the fears around LendingClub was how its loans would hold up in a financial downturn. So far, so good.
Radius could be a game-changer
LendingClub's stock is just making its way back to pre-COVID levels, but the recent closing of the Radius Bank acquisition on February 1 could change the story. Radius is a digital-only bank headquartered in Boston. At the time of the announced acquisition just before COVID, Radius had $1.4 billion in assets and $1.2 billion in deposits.
At first glance, it appears that LendingClub paid a somewhat expensive price for Radius, buying it for $185 million, equal to 1.72 times book value and 28.6 times 2019 earnings. However, that's only the beginning of the story.
LendingClub is also set to reap some $40 million in annual cost synergies from the deal, including lower regulatory costs (from having an in-house bank), as well as lower funding costs from deposits. Remember, LendingClub wasn't a bank prior to this, and had to fund a lot of its loans in the short-term with higher-cost warehouse lines.
Not only will the company reap those cost synergies, but LendingClub will also be able to hold more loans on its balance sheet against its deposits, keeping the extra economics for itself. Of course, LendingClub will still be a marketplace, but the ability to hold more loans itself if need be will take care of the funding vulnerability in rough times, and should lead to an extra $40 million in profit for every $1 billion held on its books.
If you add that on, that's potentially an additional $80 million pre-tax income LendingClub can make as a result of the acquisition. If these benefits are achieved, LendingClub is really only paying two times pre-tax earnings for Radius. Quite a steal!
Call it a comeback?
As the economy recovers from COVID, there's a pretty good shot that we could enter a strong period of GDP growth, which should benefit financial stocks. When you consider LendingClub's stock is still quite depressed from several years ago, even while the business has been transformed with a much better cost structure coming out of the crisis, and LendingClub looks like a compelling turnaround story for value investors to explore. The company reports fourth quarter results on March 10.
Correction: The original version of this article misstated how LendingClub's business practices were violated in May 2016. We're sorry for the error.