Digital marketplace bank LendingClub (LC -0.12%) has been hit hard this year, with its stock down more than 64% in 2022. LendingClub got caught up in the tech wave last year, resulting in elevated valuations that couldn't survive the rapidly rising interest rate environment.
But the company has come a long way in recent years, acquiring a bank and significantly changing the financial profile of the company to one that is much more profitable. Despite the sell-off this year, Wall Street analysts are still holding price targets that suggest significant upside in 2023. Let's take a look.
A new business model
LendingClub is an online personal-loan service that customers often use to consolidate credit card debt. At the beginning of 2021, it acquired Radius and effectively became a bank in the process. The acquisition gave LendingClub access to cheaper funding through deposits to originate loans, and being able to originate loans inside the bank meant it didn't have to pay a third party.
Following the acquisition, LendingClub also changed its business model. Before becoming a bank, LendingClub would sell 100% of its originations to institutional investors. But with the bank charter, LendingClub now holds about a quarter of its originations, give or take, on its balance sheet and collects recurring interest income on those loans. Holding loans on the balance sheet is three times as profitable over the life of the loan than is selling loans to investors. Since then, the company has grown its balance sheet, and the difference in financial results has been night and day.
LC Net Income (TTM) data by YCharts
Now, a chunk of this year's profits this year are due to the reversal of a deferred tax asset this year, but the company is still generating a nice profit this year, compared with consistently having lost money in the past.
Battling the rising rate environment
The rising interest rate environment has been particularly difficult for consumer fintech lenders that sell loans to investors, because investor demand for loans that LendingClub originates has dried up significantly.
A portion of investors buying these loans essentially fund them with their own capital, the cost of which can be tied to the Federal Reserve's benchmark lending rate. So as the Fed has drastically raised rates, these investors have had a higher cost of capital, which has led them to demand higher returns. LendingClub essentially arbitrages credit card interest rates. As these go up in the rising interest rate environment, LendingClub can also raise its loan rates. However, doing that takes time, and it hasn't fully materialized yet.
Investors are also increasingly concerned about a recession next year that could significantly affect the consumer and lead to higher loan losses for investors, so they are also probably looking for more visibility.
Watching credit on its balance sheet
LendingClub also needs to think about loan losses on its balance sheet. As a bank, the company abides by bank accounting rules, including standard loan loss reserving policies. As loans come on the balance sheet, LendingClub immediately reserves for projected losses on the life of the loans, meaning that it essentially takes losses, and the negative impact to earnings, that haven't happened yet up front. Furthermore, while it's taking these losses, the company has yet to recognize revenue from the loans.
In the third quarter, LendingClub reported consumer loan charge-offs -- debt unlikely to be collected and a good indicator of actual loan losses -- of just shy of $23 million. With a total personal loan book on the balance sheet of about $3.64 billion, that's a net charge-off rate of 0.63%, or 2.5% annualized.
But LendingClub's reserves for its total personal loan book were 7.2% at the end of the third quarter, so although charge-offs are likely to keep rising, the company appears to be healthily reserved right now.
Management also said it had previously been underwriting loans with pre-pandemic conditions in mind, and the company has also tightened its credit box in the current environment to pursue higher-quality borrowers. The average FICO score of loans sitting on LendingClub's balance sheet is 730, and these customers have an average income of $115,000.
Analysts are still bullish
Analysts' median 12-month price target for LendingClub is $16, which implies roughly 78% upside from LendingClub's current price level just below $9 per share. Whatever happens with the economy, LendingClub should benefit as rate increases slow and the company can reprice loan yields, perhaps getting loan investors back in the mix next year.
LendingClub also recently acquired a roughly $1 billion loan portfolio that it originated and sold to a bank that ended up being acquired. Because of the shorter duration of the loans, LendingClub plans to classify this portfolio as held for sale, an accounting treatment that doesn't require the company to set aside reserves for the loan pool. This should be a nice addition to earnings next year. And with total U.S. revolving debt now having eclipsed $1.1 trillion and well above pre-pandemic levels, the company's addressable market for its main use case, credit card debt consolidation, is growing.
Ultimately, LendingClub is a profitable fintech and a market leader in the personal loan space, but it's also currently trading below its tangible book value or net worth, and at 5.5 times forward earnings. This status, in my opinion, makes LendingClub both a growth and value stock. I don't know if analyst price targets will come to fruition next year, but I do think the stock has significant long-term upside from its current level.
