Consumer-lending fintechs that are overly dependent on the capital markets have been hammered this year amid rapidly rising interest rates. Investors like asset managers that typically purchase consumer loans have seen a higher cost of capital to fund these loan purchases and have also grown more concerned about credit quality, with many fearing that the U.S. economy is barreling toward a deep recession.
But the digital marketplace bank LendingClub (LC -3.58%), which combines a leading online personal lender with a bank charter, seems to be navigating the environment well. Let's take a look.
A record quarter
Founded in 2006 and making its public market debut in 2014, LendingClub has been through many different economic cycles and has seen no shortage of ups and downs.
This experience is likely what led the company, which is really good at using technology and machine learning to originate unsecured personal loans, to buy Radius Bank in 2021. The bank charter allows LendingClub to originate loans and use cheap deposits to fund a portion of them. It also sets up a better framework for putting a portion of loans on the company's balance sheet. Loans that LendingClub puts on its balance sheet and collects recurring monthly interest income on are three times more valuable over their lifetime than selling them to investors for a one-time fee.
Image source: Getty Images.
As interest rates quickly rose in Q2 and disrupted the capital markets, some consumer fintech companies like Upstart (UPST -7.89%) had to trim their second-quarter estimates and now expect to report lower revenue and a wider loss for the period. That's because they didn't have enough investors to fund and purchase their loans.
But LendingClub didn't have to worry about this as much because it has deposits to fund a good chunk of its originations and put about a quarter of these originations on its balance sheet. LendingClub also serves a high-quality borrower that makes more than $100,000 per year and has an average FICO score ranging from 720 to 730, which makes them more resilient in a recession.
As a result, LendingClub didn't have to slow down at all in Q2. The company reported its strongest quarter of originations since buying Radius, with more than $3.8 billion in the period. This led to record revenue and adjusted profit of $330 million and $46.8 million, respectively.
Looking ahead
While LendingClub's bank charter does allow it to navigate the rising-rate environment much better than other fintech specialists, the company is not totally immune.
Though LendingClub doesn't use the securitization market and sells much fewer of its loans to the likes of asset managers, after two consecutive 0.75-percentage-point rate hikes, some of the company's investors will still need time to adjust to the new rates and will demand higher returns on loans, which could temporarily pause some of the funding from this group in the months ahead.
The good news is that LendingClub will eventually be able to pass these costs onto the consumer because its core personal lending use case is credit-card debt consolidation. So as credit card lenders increase the interest rate they charge on card balances, LendingClub can raise the interest rates on its personal loans, while still offering an attractive value proposition.
However, this will take some time and put pressure on the amount of loan volume LendingClub can offload to investors in the current quarter. That's why the company's forecast for Q3 came in lower than what investors were likely hoping for given such a strong second quarter. The company is anticipating $280 million to $300 million of revenue in Q3 and about $30 million to $40 million of profit, both of which are a step down from Q2.
Still, given the intensity of rate hikes, this is a fairly gradual slowdown and LendingClub still maintained its full-year projection, which at the midpoint is for $1.2 billion of revenue and $155 million of profit.
I think this is a good result considering the environment. It is also for this exact reason that LendingClub bought the bank, according to Chief Financial Officer Tom Casey in the Q2 earnings call: "In today's environment, we are leaning more toward the bank model, being conservative on credit and using our low-cost deposit funding to hold more loans for investment and drive recurring revenue. As the economy improves, we'll be ready to lean into our fintech advantage, dialing up the marketplace to drive scale and capture market share."
Continuing to prime the pump
Amid a very difficult backdrop, LendingClub just produced its strongest quarter ever and is lowering its forecast for Q3 very modestly. The bank charter allows it to be more defensive in tough markets (like the one today) and then hit the gas in periods of growth.
Loan demand is also quite healthy and there is more than $1 trillion of revolving debt in the U.S. right now, creating plenty of opportunity for LendingClub's main use case. If balance sheet growth keeps trending the way it has been, the company could exit the year with more than $4 billion of unsecured personal loan balances, which will generate lots of recurring monthly interest revenue heading into 2023.
The market seems to still be concerned over a recession and how credit quality will hold up, and that has taken a toll on the shares, which are down 43% year to date. But considering the high-quality borrower LendingClub serves and the fact the company is reserving for loan losses prudently, I am optimistic that it can successfully navigate through difficult economic conditions. I continue to believe the stock is a good long-term buy.
