In the fourth quarter of 2021, digital marketplace bank LendingClub (LC 3.61%) reported diluted earnings per share (EPS) of $0.27 on total revenue of more than $262 million, both numbers that beat analyst estimates. However, management's guidance on originations and expected profits in 2022 underwhelmed analysts and investors, triggering a more than 30% sell-off of the stock on the day following earnings.
As LendingClub stock was the largest position in my portfolio, I wasn't exactly in the best mood last week. But after a closer look at the earnings report, I decided I'm not ready to give up on the stock just yet. I think it can still generate strong returns and significantly grow earnings in the coming years. Here's why.
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Examining the lower guidance
LendingClub, which is in the business of using technology to streamline the unsecured personal lending space, completely transformed its business model in 2021 after acquiring the branchless Radius Bank and its accompanying bank charter last year. The bank charter enabled LendingClub to gather and use deposits to fund a portion of its loans, originate loans inside the company as opposed to using a partner bank, gain regulatory clarity, and set up a better framework for holding a portion of loan originations on the balance sheet. Those changes completely caught investors off guard and at one point enthusiasm for the stock drove the price close to $50 per share (it's now trading under $18).
But management's guidance of $130 million to $150 million of net income this year implied a lower profit level than analysts had been anticipating for this year. Additionally, projected originations of $13 billion in 2022 imply about 5% growth from the run rate of originations LendingClub has originated in the last two quarters. For those valuing LendingClub as a growth story, lower earnings than expected and modest origination growth is not exactly what you want. Still, the guidance implies that revenue will grow 40% in 2022, and earnings will grow by more than 630%. But given all the noise in earnings in 2020, it's a tough comparison. Earnings in the first quarter of this year are projected to come in essentially flat from the fourth quarter of 2021.
Following the guidance and results from the fourth quarter, investors seem less willing to value LendingClub like a fintech and prefer to value it more like a bank, which comes with lower multiples. LendingClub also saw an increase in loans that will likely go bad in the quarter -- although nothing that would suggest anything over what management has been guiding -- and the company also expects to increase tech and marketing investments in 2022 that will also cut into earnings.
Where do things go from here for LendingClub?
Despite disappointing guidance, LendingClub can still grow earnings significantly in the coming years. Its most attractive earnings stream comes from the unsecured personal loan book that it holds on its balance sheet and collects monthly recurring revenue on, otherwise known as net interest income, which is the money banks make on loans and securities after covering the cost of funding those assets. The bank typically retains 20% of these on the balance sheet, although will go as high as 25%. Those loans held to completion are three times more profitable than loans LendingClub sells to other banks and asset managers.
LendingClub's business model is still driven by origination volume, but the company gets more bang for its buck by retaining the loans. For instance, in the fourth quarter of 2019, before LendingClub had the bank charter and the fourth quarter of 2021, the company did the same amount of loan originations at $3.1 billion. But because of the bank charter, LendingClub was able to harvest nearly $74 million more of revenue and $29 million more of profits from that same origination volume. The company is still early in the process of building its unsecured personal loan portfolio. Given that LendingClub plans to do $13 billion of originations, retaining 20% of that would add another $2.6 billion of unsecured personal loan originations to the balance sheet. That would grow the book by about 144% this year, although keep in mind that the actual growth will be lower than $2.6 billion because loans will be paid off early and come to completion. As the unsecured portfolio grows quickly, it will also quickly increase net interest income and boost earnings.
There is also good reason to think that LendingClub can exceed guidance this year. Management hasn't missed on earnings or its own internal guidance since it bought Radius. While investors might be frustrated by the lack of more origination growth, assuming LendingClub does do $13 billion of originations and the annual personal loan market is around $81 billion annually, that means LendingClub is still grabbing about 16% of the personal loan origination market. That is close to or at the very top of the market, so if this market grows then I am sure LendingClub will do more originations.
LendingClub CEO Scott Sanborn on the company's recent earnings call noted that in the personal loan market, "the disproportionate growth over the course of the last 12 months has really come from subprime and near prime [borrowers]." LendingClub participates in the prime space, with the average FICO score of its borrowers hovering around 700. So most of its target market is likely still in strong financial shape and may not be taking on debt like they used to.
Additionally, loan balances have begun to jump in the credit card space. Total outstanding revolving debt in the U.S. ended November at nearly $1.04 trillion. A big use case of LendingClub's unsecured personal loan product is helping people consolidate credit card debt. The Federal Reserve is expected to increase its federal funds rate this year multiple times, which many interest rates on credit cards are tied to and move with. Seeing the interest rates on their credit cards rise steadily should provide added incentive for consumers to consolidate their debt. With the average duration of loans on LendingClub's balance sheet at just over 16 months, the company can reposition its balance sheet to have higher-yielding assets in a fairly quick time frame.
Valuing the company
It seems like investors are wary to value LendingClub like a pure fintech on concerns that regulatory capital or the size of its addressable market may limit growth. Currently, the company trades about 13 times its projected 2022 earnings. Most large banks trade in the 11 to 14 range, while smaller banks with excellent return metrics can trade higher. In the middle of management's range, LendingClub projects $140 million of profit in 2022. The company's equity at the parent company was $850 million at the end of 2021, which is up about $46 million from the prior quarter. That would equate to a return on equity of 16.5%, which is very strong in the banking industry.
LendingClub also grew equity by more than 17% in 2021, likely to continue to be able to fuel growth and stay in compliance with regulatory capital ratios. That growth in equity hurts returns, but hopefully, this will slow at some point. If the company can beat guidance this year and receive an earnings multiple of around 15 to 20, there is definitely strong upside now and in the future. I do think LendingClub investors are likely going to have to be a bit more patient than I initially expected, but I still think a long-term winner exists here and plan to hold the stock.
