LendingClub: Valuation out of touch with prospects (NYSE: LC)

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Investment thesis

Lending Club (CL) is truly a great value asset at a discount. The company will grow rapidly with increasing adoption and product range and will see a dramatic improvement in profitability through a model shift made possible by its recent bank charter. The valuation of the company does not reflect its prospects. I expect the stock to reprice as the company outperforms its peers in terms of loan losses due to its higher quality loan portfolio. LendingClub is a solid buy for me.

LendingClub stands out for its quality portfolio and its growth

Many savvy investors are concerned about the shift in sentiment towards LendingClub in a rising rate environment. They think the company’s low rate sensitivity could be a headwind relative to its banking peers. Rising rates are the mainstay of my macro vision (see here and here). While most banks benefit from the rate hike, LendingClub is not among the main beneficiaries. It has below-average rate sensitivity. While the average bank has a ~4% increase in revenue from a 100 basis point hike in interest rates, LendingClub only has a 3.6% increase in net interest income from a 200 basis point hike. As rates rise, LendingClub’s earnings could be lower than their banking peers.

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Source: Company’s third quarter 10-Q

I suspect the reality could be worse than filed as well. LendingClub’s high-yield rate depositors are likely more price-sensitive than customers of some traditional banks. So, as rates rise, LendingClub will likely need to increase its deposits more than many peers. Rising rates are a net competitive negative for LendingClub, all other things being equal.

I think the macro factors benefiting LendingClub, however, offset the impact of the rate hike. American pandemic the stimulus led to a dramatic drop in non-performing loans. Artificially strengthened balance sheets benefited lenders who ventured up the risk curve. Now, with the pandemic lingering and the stimulus effects fading away, we’re likely to see a peak in loan losses. The current environment will likely benefit those with healthier loan portfolios. LendingClub is part of the latter group with its customer average ~700 credit score and ~$100,000 annual income. were already see this game with LendingClub’s 30-day delinquency rates 50% lower than its fintech peers and significantly lower than its industry. The reopening should see relative outperformance from LendingClub.

Perhaps more importantly, LendingClub’s earnings growth should more than offset the interest rate effect. The company is expected to hit $162 million in GAAP net income next year and $268 million for the year from just $18 million this year. Rising rates may be a headwind, but the company’s rapid growth makes it a problem.

And finally, while the majority of LendingClub’s income is non-interest and the majority of its origins are off-balance sheet, the situation is changing. The share of interest in income is growing rapidly, as is the share of investment in creations. Future growth figures are expected to factor in a higher proportion of interest rate sensitive earnings and future earnings are what drive LendingClub’s valuation. And as interest rate expectations rise, so will LendingClub’s earnings estimates.

Change of business model of the company to enable an excellent financial profile

LendingClub is at an inflection point in the income statement. The company becomes profitable thanks to a change in its economic model. Prior to 2021, LendingClub made money from third-party loan origination. It has received commissions from loan-owning banks and market investors for its origination services. This resulted in him receiving a small portion of the value generated from the transaction. Now, thanks to its banking charter made possible by the acquisition of Radius, LendingClub can issue the loans directly, giving it a greater share of the interest payments. This should significantly improve its profitability. His current efficiency rate amounts to 67.5% for the bank and 72.6% for the consolidated company. There’s a lot of room for improvement here with the industry average at 60.3% and some digital native peers reaching levels below 40%. LendingClub should be able to drop well below 60% over time.

LendingClub will not only become a profitable business, but a very profitable business. I have provided a chart of past company results and consensus estimates of net income margins and return on equity (ROE). The transition of LendingClub’s business model is reflected in its shift to near 20% margins and an average ROE of 20%. I expect the growing profitability of the company to attract many investors.

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Source: Capital IQ, author’s analysis

New TAM will fuel future growth

Product breadth will be important to LendingClub over time in terms of unit economics. It’s usually expensive to make the initial sale to a user, but adding additional products is much cheaper. the management reports in the original fractional cost of their recurring users. The more product options LendingClub adds, the more profitable it will be through inexpensive growth. Plus, more user interactions translate to more stickiness. The more loans a person has from a single source, the more likely they are to use that source for their next loan. The expanded product offering will result in higher lifetime value as well as lower churn for LendingClub.

I expect LendingClub to fuel its growth by adding new products to complement its core unsecured loans. The company’s AI/ML-based pricing engine can be used across various lending verticals by providing relevant data to it. LendingClub was able to lower APRs with limited additional risk in unsecured lending. It should also be able to do the same with other loan products. And the new products should be well received by the street as they would both diversify LendingClub’s revenue and provide new avenues for growth.

We are already seeing the company venture into new areas with its recent auto refinance offering. the management noted that nearly 2/3 of its members already had car loans and that car loans were the second highest monthly debt outside of housing. The opportunity is significant given the size of the $300 billion market and LendingClub’s ability to reduce APR by more than 5%. The traction is evident in the growth of the company’s 85% QoQ auto refinance origination.

I’m not just speculating on new products here, but listening to management. Quotes such as the ones below give me belief in the business:

“Going forward, we’ll tell you more each quarter about how we’re leveraging our expertise and advantages to offer our members a broader set of integrated financial solutions.”

“We are creating a powerful flywheel effect that will help our loyal and growing membership base with additional financial solutions that will save them money while increasing their lifetime value to us.”

“Over the next 12 to 18 months, we plan to accelerate our growth investments, particularly in infrastructure and new products, while continuing to grow our earnings. We expect these investments to improve our ability to serve our members. and drive sustainable growth at our peak and bottom line over time.”

LendingClub’s excellent prospects are excellent value for money

LendingClub fits many definitions when choosing peer group reviews. I will conduct two analyzes comparing the company’s relevant profitability and growth outlook and relevant forward multiples to its banking and fintech/neobank peers separately.

In my banking analysis, I compared a wide range of banks’ 2-year future earnings multiples with their ROE and the growth rate between next year and the year after future earnings. I use CY23 over CY22 growth rate to account for LendingClub’s very low EPS base this year. The company has leading growth rates and ROE, but trades well below the average and median multiples of its peers.

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The severity of the situation is not clear from the table above. To illustrate, I have plotted the variables in the graphs below. LendingClub is in a class of its own among its banking peers.

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Source: Author’s analysis

For my fintech group, I used two-year forward revenue multiples, CY21-23 revenue CAGRs, and CY23 net revenue margins in the comparison. The chart shows the LendingClub opportunity with its median revenue growth rate, high profitability and very attractive valuation.

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Again, I plotted valuation against profitability and growth to visualize the chart. LendingClub’s valuation is disconnected from its profitability and its growth is cheap (but not the cheapest).

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Source: Author’s analysis

Overall, I view LendingClub as a conviction buy. The company has excellent prospects in terms of growth and profitability which I don’t think its valuation reflects. I see the company as an excellent outperformer both in the short and long term.

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