It's no secret that the market has had a rough go of it thus far in 2022. Since the start of the year, the S&P 500 has fallen 19%. This market weakness has been even worse for up-and-coming businesses like financial technology companies, more popularly called fintechs. For example, the Ark Fintech Innovation ETF has lost over 55% since the start of the year.
Two fintech companies that skyrocketed last year only to come back down to earth are Upstart Holdings (UPST 3.90%) and LendingClub (LC 1.36%). After climbing to sky-high valuations, they have dropped 87% and 71%, respectively, from their peak prices in 2021. They look similar on the surface, but one has a distinct advantage that I believe will give it an edge in the coming years.
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Upstart and LendingClub have this in common
Upstart is an emerging fintech that wants to change consumer lending. The company's goal is to make personal loans accessible to everyone -- including those not considered credit-worthy by traditional credit scores.
The company aggregates loans through its website or app, then leverages artificial intelligence (AI) to quantify risks on 1,500 variables to make these loans.
LendingClub is a fintech that has been around a bit longer than Upstart. The company was founded in 2006 and was initially a peer-to-peer lending platform. It also leverages AI to assist it in making loans. Specifically, the company focuses on making personal loans to individuals who want to pay down credit card balances and other debts and roll that into a single loan.
The one big difference
Upstart and LendingClub have very similar business models. They both focus on writing personal loans and collecting fees for their help in writing those loans. However, one key difference is that LendingClub holds a portion of the loans it writes while Upstart does not.
Upstart's revenue model is similar to what LendingClub's used to be a few years back. For the uninitiated, Upstart is laser-focused on writing loans on behalf of its banking partners and then receives fees from those banks -- which hold the loans on their balance sheets. These fee revenues made up over 94% of Upstart's revenue in 2021.
However, what is happening to Upstart today was what happened to LendingClub a few years ago. When the lending markets tightened in 2016, LendingClub's heavy reliance on fees caused the company to alter its criteria by lowering its standards to keep generating loans -- which ultimately caused its CEO to step down.
Since then, LendingClub has altered its business by purchasing the digital bank Radius Bancorp, which closed in February 2021. Owning a bank gives LendingClub a distinct advantage over Upstart, which I believe will give it an edge in the coming years.
LendingClub should see more stable earnings
By purchasing Radius Bancorp, LendingClub can now take in deposits and issue loans without using a partner bank. This also allows the company to hold loans on its books and collect interest income from them over time.
LendingClub CEO Scott Sanborn has reiterated that holding loans on its books would sacrifice some profits today but would be three times more profitable in the long run. LendingClub's revenue sources are more diverse as a result. The fintech brought in marketplace revenue (similar to Upstart's fee revenue) of $180 million in the first quarter. However, this source made up 62% of LendingClub's total revenue, with the rest coming from interest income on the loans it services.
By holding loans on its books, LendingClub isn't relying entirely on churning out loans to drive revenue growth. Instead, the company is collecting more interest income over time, which is a more stable source of revenue if personal lending conditions do tighten. Not only that, but the company is holding loans on its books when interest rates keep rising, which should serve as a tailwind for growing interest income.
LendingClub trades at a cheaper valuation than Upstart, sporting a price-to-earnings ratio (P/E) of 13.1 compared to Upstart's 23.8. Given the cheaper valuation and more resilient business model, I think LendingClub can outperform Upstart in the years ahead.
