LendingClub Q1 2022 Earnings Review: when a Fintech company buys a bank, the magic happens

LendingClub ( LC 0.00%↑ ) reported Q1 2022 results last week, and the company’s earnings call was one of the few bright spots in an otherwise quite dark month for the markets. The company managed to beat its quarterly guidance, as well as revised upwards the guidance for the full year. If you are new to the company, I suggest you read my earlier letter on LendingClub, titled “Transition to the Marketplace Bank model continues as planned”.

In short, LendingClub started a peer-to-peer lending company, which originated personal loans online and sold those to investors. However, despite growing loan origination volumes, the company struggled to reach profitability. So they bought a bank last year (Radius Bank). Under the new business model, called “Marketplace Bank”, they continue selling part of the originated loans to banks and institutional investors earning Non-interest income, and retain the remaining part or originations on their balance sheet earning Net Interest Income. The company turned profitable (GAAP profitable) in the first year of pursuing this model.

As I argue in the text below, LendingClub does not need to deliver stellar origination growth to meaningfully increase its Net Income. As they continue retaining part of loan originations each quarter, Net Interest Income will compound over time even if loan origination growth stalls. The last few quarters are a good illustration of that!

Loan Originations

LendingClub reported $3.2 billion in loan originations in Q1 2022, which represents a 117% YoY growth compared to Q1 2021. I wouldn’t be reading much into the YoY growth, as in Q1 2021 the company was busy with the merger (closing or Radius Bank acquisition) and was not operating at its full capacity. However, QoQ growth is notable, as the first quarter of a year is usually a slow period for consumer lenders.

LendingClub operates a “Marketplace Bank” model, so they retain part of the loans on their balance sheet (“Held for Investment”, or HFI in their reporting), and sell the remaining part of originations to banks and institutional investors. Thus, in Q1 2022 they retained $856 million or 27% of total originations. They previously guided that they will be retaining 15-25% of originations.

During Q4 2021 Earnings Call, LendingClub’s management did not provide guidance for loan originations in Q1 2022, but guided for $13 billion in originations in 2022. Following Q1 2022 results, the company revised its annual guidance upwards to $13.5 billion in originations in 2022.

Loan Book and Deposits

LendingClub finished Q1 2022 with $3.2 billion in net loans held for investment on their balance sheet, which represents a 17.4% QoQ growth. As I wrote in my previous letter on LendingClub, the company’s strategy is to build its own loan book (by retaining part of originations) and create a steady revenue stream of Net Interest Income. There are downsides to keeping the credit risk (provisions, charge-offs, etc); however, the company estimated that it will be earning x3 the revenue on the loans it retains compared to the loans it sells through its marketplace.

It should be noted that LendingClub “inherited” a diverse loan portfolio from Radius Bank. Thus, Unsecured personal loans constitute only 69% of the total loan book, and the company still has $185 million in Paycheck Protection Program (PPP) loans on its books (included in the “Commercial and industrial” position in the table below). Nevertheless, the PPP loan book is running down fast, and the unsecured and secured consumer loan portfolio is the key driver of the loan book growth.

As LendingClub keeps growing loan origination and, as a result, its loan portfolio, the deposit base becomes a critical metric to track. Thus, the company finished Q1 2022 with $3.98 billion in deposits, which represents a 27% QoQ growth. Deposits are a cheap funding source, and so far LendingClub managed to grow its deposit base in excess of its loan portfolio.

Revenue

The company reported $289.5 million in net revenue in Q1 2022, which represents a 174% YoY growth. Non-interest income, which represents primarily the fees LendingClub generates from selling loans via its marketplace, grew 117% YoY to $189.9 million, and Net Interest income grew 438% YoY to $99.7 million.

Two thoughts on revenue. First, as you will see later, Non-interest income pretty much covers the company’s non-interest expenses. I guess that this is not a coincidence and that the company manages the percentage of originations it sells through the marketplace to generate such a level of income. This essentially implies that Net interest income (less provisions for credit losses and taxes) that the company earns from its loan book goes directly into Net Income.

Second, my investment thesis for LendingClub is not based on the originations growth, but rather on the growth of the company’s loan portfolio, and thus, Net Interest income. Thus, over the last twelve months, by retaining part of the originations, LendingClub grew its consumer loans portfolio from $668 million to $2.29 billion, and Interest Income from Held for Investment loans grew from $15.3 million to $91.4 million.

The company guided for $295 - $305 million in revenue in Q2 2022, as well as revised upwards its guidance for the full year 2022 to $1.15 - $1.25 billion. Some back of the napkin calculation: 4 quarters of Non-interest income of $190 million (same as Q1 2022) would generate $760 million in revenue for the year, meaning the company expects to earn $390 - $490 in Net Interest Income in 2022. They earned $99.7 in Net Interest Income in Q1 2022, so I would guess that the company’s management is quite conservative in their guidance (unless there is a market shock that negatively impacts originations).

Operating Expenses

Non-interest expenses stood at $191.2 million for the quarter, which represents a 42% YoY growth and just a 2% growth sequentially. The company grew revenue at a faster pace than its operating expenses both on YoY and QoQ levels, and as mentioned above, non-interest income (almost) covered non-interest expenses.

Two measures of LendingClub cost efficiency are a) Efficiency Ratio (Calculated as the ratio of non-interest expense to total net revenue), and b) Marketing expense as a percentage of loan originations. Thus, you can observe a decreasing Efficiency Ratio, as the company’s revenue grows at a faster pace than its costs, and an increasing Marketing expense as the company is scaling up originations. As mid-term targets, I would expect the Efficiency Ratio to decrease below 55%, and the Marketing expense to increase to the pre-pandemic level of 2%+.

Net Income

LendingClub reported a Net Income of $40.8 million for the quarter, an improvement from a Net Loss of $47.1 in Q1 2021. Just in case, this is GAAP Net Income, which is so rare in the Fintech world. The “Marketplace Bank” model that LendingClub pursued with the acquisition of Radius Bank is working, and the Net Income is expected to increase with the growth of the loan portfolio.

The company guided for $40-45 million in Net Income in Q2 2022, and also revised upwards the annual guidance to $145 - 165 million. Again, some back of the napkin calculation: they earned $40 million in Q1, and guiding for $105-165 million for the rest of the year. As mentioned above, Non-interest income covers operating expenses; thus, LendingClub’s management guidance implies $105-165 million in Net Interest Income less provisions and taxes. Similar to revenues, this looks like conservative guidance to me, unless the economy goes into recession, and LendingClub’s origination volumes start falling.

Things to Watch in 2022

• Origination volumes. Loan origination volume is the key LendingClub’s metric to watch this year. If they manage to achieve their target for originations, then we can expect continuous build-up of the loan book and Net Interest Income, as well as sufficient Non-interest income from the loans sold via the marketplace to cover operating expenses.

• Share of retained loans. LendingClub’s management reiterated their target to retain 15-25% of originations; however, the company actually retained close to the upper bound of the range during the last two quarters. My understanding is that the management is looking to sell the minimum amount needed to cover the operating expenses. Thus, if origination volumes exceed their targets, we can see a higher share of loans retained on the books of LendingClub.

• Economy and Inflation. The consumer lending business is highly sensitive to the state of the economy and consumer sentiment. Inflation might lower consumer disposable income (negatively impacting repayments), and an economic recession (and thus, less certain job prospects) might hinder the demand for consumer loans. I think, if there is anything that can stop LendingClub from delivering another stellar year, then it is the economy.

Source for all financial information: LendingClub Quarterly Fillings

Disclosure & Disclaimer: despite rocky performance in 2021 and early 2022, I have open positions in most of the companies covered in this newsletter, as I am extremely bullish on the transformation in the financial services industry. However, none of the above is financial advice, and you should do your research.