LendingClub Corp Q1 FY2024 Earnings Call

Good afternoon. Thank you for attending the LendingClub First Quarter 2024 Earnings Conference Call. My name is Jayla and I'll be a moderator for today. I would now like to pass the conference over to our host, the Head of Investor Relations, Artem Nalivayko.

Thank you, and good afternoon. Welcome to LendingClub's first quarter earnings conference call. Joining me today to talk about our results are Scott Sanborn, CEO; and Drew LaBenne, CFO. You can find the presentation accompanying our earnings release on the Investor Relations section of our website. On the call, in addition to questions from analysts, we will also be answering some of the questions that were submitted for consideration via email. Our remarks today will include forward-looking statements, including, with respect to our competitive advantages and strategy, macroeconomic conditions and outlook, platform volume, future products and services, and future business and financial performance. Our actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are described in today's press release and presentation. Any forward-looking statements that we make on this call are based on current expectations and assumptions, and we undertake no obligation to update these statements as a result of new information or future events. Our remarks also include non-GAAP measures relating to our performance, including tangible book value per common share and pre-provisioned net revenue. You can find more information on our use of non-GAAP measures and a reconciliation to the most directly comparable GAAP measures in today's earnings release and presentation. And now, I'd like to turn the call over to Scott.

All right. Thank you, Artem. Welcome everybody. We kicked off the year with another solid quarter, and we're pleased with how well we're executing against the factors we can control, derisking the business while also advancing our strategy and setting the stage for future growth. Our operating discipline, credit outperformance, and continued innovation are resulting in a sustainable operating rhythm that has us well positioned to outperform as conditions improve. Let's start with our loan volumes. Total originations for the quarter came in just above $1.6 billion, which was in line with the prior quarter despite typical adverse seasonality. Pre-provision net revenue of $48 million came in above the high end of our range, thanks to strong execution combined with temporary benefits in both expenses and loan sales prices. Importantly, we delivered net income of $12 million, marking 12 straight quarters of GAAP profitability since we became a bank, a notable feat given the turbulent macro environment over the last 2 years. In February, we successfully exited the 3-year operating agreement required of us as a new bank, a milestone in our evolution that gives us more flexibility in how we manage the business. Our management priority is currently deploying our excess capital to build the balance sheet and bolster our net interest income, which we believe is the best way to drive durable shareholder value in a higher-for-longer environment. For example, this past quarter, we grew the balance sheet by $415 million, adding new originations in the form of whole loans and securities, and a repurchase of a portfolio of previously sold LendingClub loans. These actions to increase the balance sheet will support a return to growth and net interest income going forward. Now turning to credit, where we continue to demonstrate our leadership. You'll see on Page 9 of our earnings presentation that we've delivered our 13th consecutive quarter of material outperformance versus our competitive set across all core customer segments that we serve. This outperformance reflects our vast data advantage derived from over $90 billion in issued loans, our flexible technology platform that allows us to rapidly respond to changing market dynamics, and the efforts of our highly seasoned team with the human intelligence to look ahead and beyond the models. Our sustained credit performance gives us confidence in our ability to increase shareholder value through a sustained elevated interest rate environment. And it firmly reinforces our position as the partner of choice for marketplace investors. Turning to the marketplace, where asset manager demand for our structured certificate program remains strong. We sold over $785 million of new issuance through the program this quarter generating fee revenue and capital-efficient risk-remote interest income without an upfront CECL charge. Beyond asset managers, conversations with select banks are gaining momentum. Depending on the rate environment we are cautiously optimistic that we'll see engagement beginning in the back half of this year, which should help drive up pricing and corresponding marketplace revenue. Given the consistent demand that we're seeing from asset managers and the momentum that's building with banks, we are increasing our Held for Sale portfolio, which provides interest income near-term and the potential for sales at higher gains down the road. Stepping back, as credit card balances and average APRs hit new highs, our TAM has never been larger and our value to consumers has never been more compelling. Refinancing credit card debt through a LendingClub loan provides substantial savings and has been shown to increase a borrower's credit score by an average of 48 points. And we make it easy with new borrowers able to apply in a matter of minutes and existing members able to redeem a pre-approved offer in a few clicks. For LendingClub, these borrowers deliver strong credit performance, high marketing efficiency, and a powerful opportunity to engage and reward them over time. Given the historic refinance opportunity in front of us, we're focused on coiling the spring to enable accelerated growth when conditions permit. We're building on our 15-plus years of industry leadership and further elevating and differentiating our offering through several initiatives that include, an increasingly robust set of credit monitoring and management tools that provides members with visibility into their credit profile, current debt, and the cost of that debt, all of which serves to highlight the personal loan value proposition. With just the credit profile portion of the functionality live, we're seeing enrolled members visiting us close to 50% more often than those who haven't. With these positive early results, we're excited about the broader debt monitoring portion of the experience that's currently live and testing with a select group of members in advance of a broader release later this year. A second initiative is a turnkey embedded finance integration that enables digital delivery of personalized, pre-screened loan offers via advertising. We are testing this functionality on our own site, where we're seeing substantial lifts in response and approval rates from high-quality borrowers, and we hope to offer the integration to select partners as we exit the year. We're also iterating on unique to LendingClub member products, such as TopUp and CleanSweep, that offer members a powerful benefit to staying engaged with us. TopUp allows members to easily add incremental funds to their existing loan balance while maintaining a single payment within their budget. We're currently testing our way into the program, and we're seeing materially higher response rates and issuance volumes. CleanSweep is a revolving line of credit that gives existing members a way to easily sweep new credit card balances into a fixed payment plan, allowing them to get the card rewards they love while saving on interest if they need to carry a balance. CleanSweep provides a compelling, easy-to-access experience that is unique to LendingClub and drives ongoing engagement. It's also the first step towards offering other revolving use cases down the road. While we have an extensive learning agenda here, early results again show extremely positive response and take rates. These and other new initiatives are helping us deliver on our promise to relentlessly advantage our members by delivering financial solutions that are smart, simple, and rewarding. The positive early results help us offset our typical seasonality in Q1, and we expect them to deliver nearly $0.5 billion in new high-quality issuance this year. Equally importantly, these initiatives further differentiate LendingClub's offering in the market and set the stage for longer-term growth. In closing, I'm incredibly proud of what we've been able to accomplish through this environment, including delivering consistent GAAP profitability, remaining strong stewards of credit, rapidly innovating to meet investor needs, innovating on new tools, features, and experiences to deliver value for our members, and successfully exiting our operating agreement. We're now reaching a sustainable baseline from which we can expect to grow originations, our balance sheet, and our member base. We will do so modestly if the current rate conditions persist with a more pronounced acceleration as the Fed's interest rate policy eases. I'll again thank the entire LendingClub team for their continued innovation and dedication to our mission. Thanks to their hard work, we're well positioned to capture the incredible opportunity in front of us. With that, I'll turn it over to Drew.

Thanks, Scott. And hello, everyone. Let me walk through the details of our first quarter results, starting with originations. As Scott mentioned, we originated over $1.6 billion in line with the prior quarter and the high end of our guidance. Last quarter, we added Page 10 to our earnings presentation to illustrate the relative economics of the 4 primary programs we have at our disposal to sell or retain loan originations. Whole loan and structured certificate sales allow us to take more upfront economics and operate in a capital-like manner without credit risk, whereas loans that we hold or season on balance sheet provide the strongest returns. On Page 11, you can see the origination volumes of the 4 programs. The issuance in the quarter was once again led by our very successful structured certificate program, which was approximately $785 million of the originations in the quarter. We also sold $320 million of whole loans through the marketplace, accumulated $255 million into Held for Sale for our extended seasoning program to meet future marketplace investor demand for season loans. And we retained $285 million in our Held for Investment portfolio. This quarter, you saw us increase the amount of whole loans retained on our balance sheet between the Held for Investment and extended seasoning programs, which represented 32% of total originations, up from 17% in the prior quarter. We plan to maintain these higher levels of whole loan retention to offset the maturation of our existing portfolio, keeping our total loan portfolio essentially flat through the remainder of the year. Importantly, the total balance sheet will continue to grow as we add structured certificate securities throughout the year. Now, let's move on to pre-provision net revenue, or PPNR. PPNR was $48 million for the quarter and came in above our guidance range due to temporary outperformance on expenses, as well as rate-driven improvements in marketplace economics. Let's move into the 2 components of PPNR, starting with revenue, where you can see the detail on Page 12 of our earnings presentation. Total revenue for the quarter was $181 million compared to $186 million in the prior quarter. Let me break revenue down into the 2 components starting with non-interest income. Non-interest income was $58 million in the quarter, up from $54 million in the prior quarter. The improvement was primarily driven by better marketplace loan pricing as we saw continued strong demand combined with lower interest rates in the period. The pricing benefit was partially offset by lower origination fees as we retained more loans in our Held for Investment portfolio, where the origination fee is deferred over the life of the loan. Now, on to net interest income, which was $123 million in the quarter compared to $131 million in the prior quarter. The change in net interest income was primarily due to the continued shift towards putting structured certificate securities on the balance sheet, which have no provision due to the risk-remote nature of the A-note security, but come with a lower asset yield. This is the third quarter since we started the shift in balance sheet composition. And going forward, we should see modest improvements in net interest income with further benefits when the Fed begins to lower interest rates. As Scott noted, we purchased a $235 million LendingClub issued loan portfolio from a marketplace investor at the end of the quarter, which we accounted for under fair value, and funded it with short-term federal home loan bank advances that have been repaid as of this call. As you have seen us do in the past, we will be opportunistic about secondary portfolio purchases of LendingClub issued paper. We see this as a way to quickly deploy excess capital and earn attractive returns while providing liquidity for our marketplace investors. Risk-adjusted revenue, which is net revenue less provision, increased to $149 million this quarter from $144 million in the prior quarter, which was the result of the lower provision as we continued growing the structured certificate and extended seasoning programs. We introduced this metric last quarter as we believe it illustrates the lower risk nature of the assets we have been using to grow the balance sheet. The continued evolution on the asset side of the balance sheet has had the expected impact on net interest margin. On Slide 13, you can see that our net interest margin was 5.8% in the quarter compared to 6.4% in the prior quarter. We expect the rate of net interest margin decline to moderate going forward from what we've experienced in recent quarters, assuming the Fed has done increasing rates. Now, please turn to Slide 14 of our earnings presentation, which refers to the second component of PPNR, non-interest expense. Non-interest expense was $132 million in the quarter, compared to $130 million in the prior quarter. While we will continue to remain disciplined on expenses, we do expect to step up in variable spend to support growth as well as higher depreciation from some of the recently completed technology builds you heard Scott discuss earlier. Now, let's turn to provision. On Page 15, you will see provision for credit losses was $32 million for the quarter compared to $42 million in the prior quarter. The sequential decline was a result of lower incremental provision on older vintages, partially offset by higher day one CECL provision from the higher retained loans in the period. As we indicated last quarter, we believe delinquencies and net charge-offs on our Held for Investment portfolio have peaked and are beginning to decline as the portfolio ages past the point of peak dollar net charge-offs. Delinquencies also benefited from seasonal impacts, and to a lesser extent, temporary hardship plans tailored to the inflationary environment. On Page 16, we have updated our lifetime loss expectations for each of our annual vintages. We are seeing stable performance in line with the expectations we provided last quarter, and the marginal ROEs remain very strong across the vintages. As a reminder, we have applied a higher qualitative reserve to the 2023 vintage, given the longer remaining life compared to the more seasoned vintages. And on Page 17, we have included the illustrative example of the credit life cycle of a single hypothetical vintage. We noted on our last call that the dollar charge-offs peak at approximately 1.5 years. Our Held for Investment portfolio is now 16.5 months old, and we saw that net charge-offs were stable sequentially as we expected. Going forward, we expect dollar net charge-offs to begin to decline as the portfolio continues to season. As a reminder, our end-period net charge-off rate will continue to increase as the portfolio ages, but on lower outstanding balances. We have already taken an upfront CECL provision for future net charge-offs on a discounted basis, which is reflected in the portfolio allowance. Due to this timing dynamic, we continue to expect lower in-period CECL provisions compared to dollar net charge-offs in the coming quarters, and our in-period net charge-off rate will continue to increase as the portfolio ages, but on lower outstanding balances. This is in line with our previous expectations as our portfolio ages. Now let's move to taxes. Taxes in the quarter were $4.3 million, or 26% of pre-tax income. As I've mentioned before, we will have some variability in the effective tax rate from quarter-to-quarter, but our long-term tax rate expectation is 27%. That brings us to net income. Net income for the quarter was $12 million, or $0.11 per share, and our tangible book value per common share increased to $10.61. As Scott mentioned, this marks our 12th consecutive quarter of profitability. Now, let's move on to guidance. For the second quarter, we anticipate stepping up originations to a range of $1.6 billion to $1.8 billion, given the success we're seeing from our recent initiatives that are driving efficient, credit-worthy borrower acquisition. Our PPNR guidance range of $30 million to $40 million reflects the forecasted originations growth and related variable expense, offset by the revenue impacts on sales price from interest rates moving higher in Q2, and the expense growth from strategic initiatives I discussed earlier. And we plan to continue to deliver positive net income in the second quarter, though not at the level seen in Q1, which benefited from the one-time items I discussed earlier. As we look beyond Q2 to the back half of the year, there are a few trends I would like to call out. As Scott mentioned, we are seeing positive early performance on our new product and marketing initiatives, which we expect to drive incremental originations throughout the year. We expect to be able to maintain PPNR in the back half of the year in line with our Q2 guidance, with modestly increasing revenue offsetting the increase in expenses related to volume growth. While it's looking less likely that we will get significant rate relief in 2024, any potential reductions would be an accelerant to growing revenue. With that, we'll open it up for Q&A.

Congratulations on a great quarter. I wanted to ask about the improvements you observed in the marketplace. It's clear that margins and pricing have increased, but I'm interested in how the yield has changed compared to last quarter and what that means for the discount rate and fair value assessments.

Yes, Giuliano, it's Drew. Thanks for the question. Yes, so in Q1, we did see price increases, and that was a combination of the interest rate environment being helpful as rates came down for most of Q1. And we also saw, I think, in the market, we saw credit spreads tighten as well, which really affects how asset managers think about the price they pay for the structured certificates and for our loans. So both of those things were helpful to pricing, and we definitely saw a lift there. With the discount rate, as a reminder, the discount rate for us is a result of the prices that we're receiving on the loan. So the discount rate went down from 9% to 8.5% in the quarter. Now, I would say as we go into Q2, I think everyone knows what has happened with the yield curve and rates in particular and the 1.5 year, 2-year points, which are most important to us, have moved up pretty materially. So that's going to be somewhat of a headwind on price as we go into Q2. And that's factored into our guidance already as well.

And then thinking about the extended season program, you obviously had an earlier than expected sale last quarter, you kind of building balances. It seems like you implied that there was an opportunity to continue to grow those balances in anticipation of more demand in the back half of the year. I'm just curious how to think about how far you'd be willing to take the extended seasonal balances over the into the back half of the year?

Yes. Giuliano, I'll start, and maybe Drew, you can talk about the balance sheet management, but this program started as a result of investor interest over last summer. Frankly, the demand we've had till now has been strong enough that we're not building the portfolio at the rate we'd like to because we're getting bids as we're building. The fact that we're building it right now is a bit of a sign of our confidence, which is being reinforced by both the credit performance we shared today, but also what we're hearing from investors. People are looking to us for longer-term commitments. We're seeing really consistent, strong demand from asset managers, and as we mentioned in the call, we're cautiously optimistic. Well, we don't expect banks en masse to be back where they were pre-Q1 of last year, we are certainly seeing building momentum with a group of what I'd call idiosyncratic institutions that have capital to deploy. And in general, people are looking to start with a portfolio of some size. And so that's what's giving us the confidence to begin accumulating for that.

The only thing I would add, Giuliano, is that transaction we did in Q1. It's worth noting that we actually executed that through the structured certificate program. So I think there's also the opportunity to combine the structured certificates with the extended seasoning in terms of how we execute transactions in the future, not exclusively, but on a case-by-case basis.

So in terms of total size, I don't think we're giving a destination there, Giuliano, but will be measured this will be informed by stress testing and liquidity management and all those pieces. So it'll be measured, it'll be part of the mix.

Yes, and just as a reminder, Giuliano, last thing, I promise. We put those loans on the books at a discount, which I think is important because as we're holding them and seasoning them, as we're getting principal payback before we sell, we're getting that payback at par. So that results after we take the initial discount putting it on the books, it results in higher yield while we're holding it on the balance sheet.

Then I just have one, hopefully very quick one. I think, I didn't hear you guys very well when you mentioned the size of the portfolio that you repurchased of existing LendingClub loans. I'm not sure if it was $235 million or $285 million. I just wanted to confirm.

$235 million. Yes.

Congrats on a great quarter. And it's good to see great progress.

I wanted to follow-up on your comments about some of the idiosyncratic banks that are kind of passing the waters here about buying some of your loans. Historically, they have paid higher premiums relative to asset managers, and I'm wondering if you could maybe tell us how far along you are in these discussions? And is the pricing opportunity looking opportunistic relative to what you've been seeing from asset managers in recent periods?

In terms of our progress, we are optimistic about seeing some activity and engagement in the latter half of this year. The onboarding process for banks typically takes longer than for asset managers due to their requirements for third-party oversight. Additionally, because of the advantages in cost of capital, banks usually charge a higher price than asset managers, and we expect this trend to continue in this situation as well.

That's definitely good news. Kind of a follow-up on credit, looking at it is also positive that you kind of held your cumulative loss expectations on the 2022, but more importantly, 2023 vintage constant. Looking at the slide deck, it looks like you're assuming maybe a cumulative loss rate on the newer vintages that you're doing right now. Is that kind of the correct way to look at the slides? And what gives you the confidence of the lower cumulative loss rate expectations on some of the newer loans you're making?

Yes, Bill, I believe you're referring to the example that showed 7.8%. We haven't provided any details yet on the new vintages we're developing in HFI, so I would consider that slide as purely illustrative. It's meant to emphasize the timing of our aging portfolio and how charge-off trends and net charge-off rates evolve over time. However, I want to emphasize that for the 2024 vintage, we are very optimistic about the credit we're originating and are witnessing strong, stable performance, as Scott highlighted in the prepared remarks.

And then one last quick one on one of the credit card companies had mentioned that they're reducing credit lines on borrowers that consolidate their debt, obviously, preventing them from potentially reloading. Have you seen any increased incidence of that? Or has it been pretty stable relative to the past?

Yes, our performance has been quite stable, Bill. There have been no changes in trends as we noted during the call. We understand the use of proceeds, unlike in home improvement cases or others, which allows us to predict credit performance more reliably. We're actively engaged in this and, regarding post-loan behavior, we haven't observed any significant shifts. This holds true across the board, as you can see in the details shared in the earnings presentation related to delinquencies and hardships. Overall, we are witnessing stable to improving delinquency rates across all FICO bands. The same stability applies to prepayments over the past couple of years.

So I had a follow-up on the credit buyer demand question. So you mentioned about the structured certificate program, demand is strong. Extended seasoning, demand is strong. Curious about credit buyer demand for regular whole loans. Are you seeing any change in the appetite there?

No, not really. Probably one thing to think about is once we introduce the structured certificate program for certain asset managers, they are often getting what they wanted to get out of a whole loan purchase with more efficient execution. So I wouldn't totally bifurcate those 2 buckets in your thinking about demand, right? So some of the whole loan demand has pulled into structured certificates because of the advantage of that structure.

And on the secondary portfolio purchase, the $235 million, how much of a discount, if any, were you able to purchase those?

Well, maybe I'll just go straight to the yield that we put on there. So we expect those to yield about $12.65 when they come on, which is just a little bit less than where I think that other portfolio is at that's been obviously paying down over the past year. So pretty healthy yield that we're getting from the purchase.

And then last one for me is on shifting to capital management. You alluded to in February exiting the operating agreement with regulators. Is the priority organic growth from here? Or are you considering any other contemplated actions on the capital front?

Yes, I mean, as we said in the prepared remarks, the good news here is we've got optionality now. We've got more flexibility. I think we're consistently going to be looking and evaluating all options. The priority is certainly building the balance sheet for sustained profitable growth, especially now given the higher-for-longer environment. What's really driving the business is the fact that since we acquired the bank, we've tripled the balance sheet and grown net interest income from about $20 million a quarter when we acquired the bank to the majority of our revenue now, $120 million a quarter. So until we get a bit more clarity on the outlook, it's our view that that focus is driven by sustained profitable growth, which we know can come through investing in the balance sheet as sort of the first priority. But continuing to look at all options.

I'm curious about your comments on Q2, especially in a higher for longer environment but with stable interest rates potentially dropping later in the year. How should we consider the fair value marks on the loans sold and the cadence throughout the year? Are there different channels that are currently paying you varying amounts?

The main factor influencing the fair value mark will be the structured certificate program, where most of the sales are occurring. Pricing typically aligns with the 1.5 to 2 year period. As previously mentioned, entering Q1, there were expectations of an imminent Fed rate cut. Those points on the curve decreased significantly, rebounding by the end of Q1, and have continued to rise since then. This will influence pricing in the short term and is factored into our PPNR guidance. We are accounting for this high rate environment. Additionally, if we maintain this environment for an extended time, we can still function effectively. While pricing on structured certificates may be tighter in a higher rate situation, we believe we can continue to operate profitably moving forward.

Yes, and in terms of pricing on the fair value portfolio, obviously a big driver now that is outside of our control is the rate environment. The one that's inside of our control is credit. And so one of the things that's been pressuring prices has been uncertainty about the broader macro outlook, uncertainty on the health of the consumer, future credit losses, trajectory of unemployment. So as we post quarter-after-quarter of consistent results here. And then you add in seasoning where you hold loans for, call it 7 months, 8 months, 9 months, you really have a low range of potential outcomes. You get a lot of certainty in the credit outlook. So some of that stressing of future losses goes away. So that's a piece that we can actually control and that would somewhat offset at least part of the rate volatility.

And then you mentioned a couple new programs to drive incremental growth, like the embedded finance program. What kind of partners will you look to kind of add on to that program to drive some growth?

Yes. Just one other thing. I'll answer it. Just one other thing on the portfolio sales. Just one of the other things we've seen and one of the things that's driving the purchase demand is some of our partners' capital deployment needs can be lumpy, right? And so they've got capital, they need to deploy. Our ability to present a seasoned pool, we can't actually get better execution on that than the normal flow programs because there's a moment-in-time needs. That's just another thing that's playing into our conviction to build this because we've seen it multiple times now. So, yes, on the new program you mentioned. So again, just to explain what it is, it's basically a simple way to think about it is like the process you use to run an offline program, say direct mail, where you're pulling a list, pulling credit, qualifying people, mailing them offers, and kind of this batch-based process. We're making it more real-time and bringing it online, right? So the way to think about it is as opposed to emailing people and saying, hey, we have an offer for you, come visit us and redeem it. As we build these engagement platforms, we mentioned we put our app into the market for loan buyers and we're seeing, but still without marketing as we optimize that program, we're seeing 15,000 downloads a month coming at us. And those people we're seeing visit us more often. We're adding this credit and debt monitoring, we expect that to drive higher visitation. Our banking experience will drive higher visitation, so as we get higher visitation, we're moving to the ability of when you come to us, we should be able to present to you right there in the moment a pre-approved offer, and then export that. So the partners, the experience will vary depending on the partner, but the basic idea would be, let's call it for an existing use case where we have a purchase finance business. To the extent that some of these partners of ours have a client list of people who are debating certain procedures, we can go to them and say, hey, we can pre-qualify your list, you can actually invite people in, and tell them that they're pre-approved for an offer. There's also partners who are in the third-party credit monitoring and management space where we could effectively deliver a remote offer on their site, right? So think about the people out there that are helping people manage their credit profiles. That'd be another use case.

Will those be loans you keep, or will the mix align with what you currently originate?

Yes, you can just think about it as another source of qualified traffic. And the point I tried to make on the call, but it bears repeating, is what we're seeing here is versus a broad-based, non-qualified outreach, a targeted outreach where you're saying you are pre-approved, you actually get higher loan volume because the response is so much higher when you tell someone you're approved. And we also get a better credit profile through. So we're continuing to optimize our efforts and our focus is continuing to drive credit performance. And this is a way for us to actually get better credit quality through at strong volumes to help drive that performance.