Earnings Call Transcript - LC Q1 2021

Operator, Operator

Good day. And welcome to the LendingClub Q1 ‘21 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Sameer Gokhale, Head of Investor Relations. Please go ahead.

Sameer Gokhale, Head of Investor Relations

Thank you and good afternoon. Welcome to LendingClub’s first quarter 2021 earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO; and Tom Casey, CFO. Our remarks today will include forward-looking statements that are based on our current expectations and forecasts, and involve risks and uncertainties. These statements include, but are not limited to, timing and benefits from our acquisition of Radius and resulting bank charter, platform volume and the future performance of our business and products. 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 our most recent Forms 10-K and 10-Q, each filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements. Also, during this call, we will present and discuss both GAAP and non-GAAP financial measures. A description of non-GAAP measures and reconciliation to GAAP measures are included in today’s earnings release and related slide presentation. You can find both the press release and slide presentation on the Investor Relations section of our website at ir.lendingclub.com. And now, I’d like to turn the call over to Scott.

Scott Sanborn, CEO

Okay. Thank you, Sameer. Good afternoon, everybody, and thank you for joining us. When we last talked, I told you that with our acquisition complete, we will be evolving to a new business model, that of a digital marketplace bank. I shared that this model would be positioned to outperform and deliver sustained growth and profits, fueled by our leadership in personal loans and our considerable strategic advantages. Accordingly, I’m happy to report that we are off to a great start to the year. Our Q1 results came in above the high end of our guidance, as we accelerated originations 63% quarter-on-quarter and increased revenues 40% to $106 million. What’s even more exciting is that our Q1 activities will deliver an additional $70 million in interest income in the quarters to come, representing a new recurring revenue stream that will continue to grow as we build our loan portfolio. This is just one clear example of the benefits of adding the digital bank. As I have said previously, personal loans will be our near-term economic driver and will pave the road to our broader future as a full-service digital bank. It is a great time to be launching a digital bank, and we are starting from a position of strength, given our ability to attract valuable creditworthy customers at scale and to save their money through a seamless experience. In addition to our new lower funding costs, LendingClub has multiple competitive advantages. Our Q1 results and our sustained growth over the long term will be built on how we leverage these differentiators. Our advantages include our large and loyal base of members, our data supremacy based on information on over $60 billion in loans, our tech platform that allows us to deliver a fast and frictionless experience, our marketplace model that enables us to efficiently serve a broad range of customers and now our digital bank, which provides structural, financial and strategic benefits to expand customer lifetime value and to accelerate earnings growth and diversification. Let me spend a minute on each of these. First, our members; our results demonstrate the continued benefits of having a large and loyal installed base of 3 million members. The majority of our loans in Q1 were to our existing member base, which drove significant marketing efficiencies. These loans were originated at a fraction of the cost compared to loans to new members, and they also demonstrated lower credit risk. As the economic outlook has improved and with our digital bank acquisition complete, we have ramped marketing back up to deliver a 63% increase in total loan originations, which includes a 135% increase in originations to new customers. While consumer demand is currently below pre-pandemic levels and the competitive market is dynamic, we believe that we are well-positioned to outpace the market’s overall growth rate and capture significant share. Our second key differentiator is our data and technology leadership, supported by 15 years of significant investment and our experience with more than $60 billion in loans. This provides us with an enormous data advantage in both origination and servicing. We apply the latest analytical techniques, including neural networks and machine learning, to inform our decisions. We deployed dozens of models to drive our targeting, fraud detection, underwriting, pricing, servicing and user experience, and to manage outcomes for distinct customer segments. This allows us to make compelling offers to customers while providing competitive returns for platform investors. It also allows us to automate originations and efficiently grow loan volume without a proportional increase in headcount. As the economy recovers and we normalize our underwriting, we expect more than two-thirds of our loans to be automatically approved while maintaining fraud rates in the low single-digit basis points. That’s one of the lowest in the industry. Our ability to assess and manage risk and to quickly adapt to the environment is evident in the results during the pandemic. Looking at the latest performance data from dv01, LendingClub is outperforming the market in all credit segments in which we compete, with delinquency rates that are over 35% better than the average. In addition to our performance, the asset class more broadly has validated its place in the payment hierarchy. A recently released study from TransUnion confirms our internal data that customers prioritize payment of their personal loan obligations above many others, including credit cards. These compelling results for the category in general and for LendingClub in particular are boosting loan investor demand for our assets. This is critical because, even with the addition of our digital bank, the majority of our personal loans continue to be funded through our marketplace, which is our third key differentiator. Our broad range of investors allows us to serve a wide range of customers at competitive prices, supporting our industry-leading marketing efficiency. Our final differentiator is our digital bank, where we are immediately capturing significant financial benefits. One, funding costs are down approximately 300 basis points versus what we paid in 2020. Two, we lowered our origination costs by eliminating fees to third-party banks. And three, as I already mentioned, we’re building a significant new revenue stream from retained loans that will drive higher revenue per loan and accelerate our growth. We also continue to win accolades. In March, CNET recognized our consumer checking account as the best overall, beating out both traditional and online-only banks. Our digital bank was recognized by Celent, a leading research firm focused on technology for financial institutions for our innovation on PPP. In just six days, we released an offering that has cumulatively delivered over $870 million in loans, helping small businesses keep more than 75,000 people employed. So, taken together, our large and loyal member base, our data and technology leadership, the marketplace itself, and of course, our digital bank create a powerful new business model. Relative to banks, we expect to grow more rapidly and be more efficient at customer acquisition. Compared to traditional fintechs, we will be higher earning and more resilient. We are on a mission to help our members manage their lending, spending, and savings, and to make it easy for them to make the smart choices with their money. In closing, I’d like to thank all the LendingClub employees who worked to get us off to such a strong start, and especially thank the team at Radius Bank, who are now part of LendingClub and are working hard to accomplish our Zoom-based integration. With that, I’ll pass it over to you, Tom.

Tom Casey, CFO

Thank you, Scott, and good afternoon, everyone. As Scott mentioned, we delivered a strong quarter and grew originations by 63%, with 40% growth in revenues and an entirely new revenue stream beginning to build. Our results came in well above the upper end of our guidance range for originations, revenue, and earnings. We have lowered our funding costs and eliminated our issuance costs, and as we continue to grow originations, we expect commensurate growth in our marketplace revenue. Strong growth in marketplace revenue will generate capital, allowing us to fund growth in our highly profitable consumer loan portfolio. This will accelerate our overall revenue growth and prime the pump for recurring high-margin earnings for years to come. So with our differentiated marketplace bank model, we benefit from the best of both worlds: our capital light fee-based marketplace business and our high-margin bank model. Now, let me walk you through the new financial recording format we adopted with the closing of the digital bank acquisition. We believe the new format will help facilitate a better understanding of the key drivers of profitability and comparisons to our peers. We’re moving away from our historical focus on adjusted EBITDA and shifting our focus to managing to GAAP financial results. Let’s walk through the financials. Again, Q1 revenues grew 40% sequentially compared to our expectations of 15% to 25%, reflecting stronger loan origination growth as we opened some of our marketing channels. The difference between origination growth and revenue growth is due to the deferral of fees associated with loans we retained on the balance sheet, which will generate recurring revenue over time. Adjusted for these deferrals, revenue growth for the quarter would have been in line with origination growth at 64%. Net interest income for the quarter was $18.5 million, up from $2.9 million in the prior quarter. This reflects two months of interest income from Radius assets, as well as the interest income from consumer loans we started to retain during the quarter. In Q1, we recorded a CECL provision of $21 million, which included $7 million for day one CECL expense to build credit loss reserves for the acquired Radius portfolio. Operating expenses for the quarter were $134 million, approximately $10 million reflected Radius’ operating expenses for the two months, as well as an increase in compensation expenses as employee salaries returned to pre-pandemic levels on January 1. Marketing expenses also increased for the quarter, reflecting the opening of marketing channels I mentioned earlier. Lastly, we incurred approximately $9 million in non-recurring acquisition-related expenses. Just to recap, we had three items that drove almost all our GAAP loss for the quarter: revenue deferrals net of cost of $14 million, $21 million of CECL provisions over actual credit losses, and non-recurring acquisition expenses of $9 million. Taken together, these items represent $44 million of our GAAP loss of $47 million. In terms of capital, we capitalized the bank with $250 million of cash, and we held $76 million of unrestricted cash at the holding company. At the end of the quarter, the bank had a CET ratio of 22.2% and Tier 1 leverage ratio of 12.9%. The difference between these ratios primarily reflects the significant amount of cash and securities on the bank’s balance sheet. We intend to redeploy a significant amount of the excess liquidity into loans over time, driving higher net interest income, and we will remain prudent about how we manage our capital. We’ve had a very good start to the year. Looking at the second quarter and the rest of 2021, we expect continued strong growth in the marketplace, and we’ll continue to build our portfolio, driving a very profitable recurring earnings stream. Marketing channels that were shut down last year are up and running, and we’re seeing strong loan investor demand. Now let’s turn to our outlook for Q2 and the full year. We expect Q2 revenues to be in the range of $130 million to $140 million, up 23% to 32% sequentially, with full-year guidance increasing from $480 million to a range of $500 million to $530 million. With the success we saw in Q1, we are projecting Q2 originations to range between $1.7 billion and $1.9 billion, up 15% to 28%. For the full year, we’re increasing our outlook from $6.3 billion to a range of $6.8 billion to $7.3 billion. Our GAAP earnings will continue to reflect deferred revenue and CECL provisions depending on the amount of loans we retain. We expect Q2 GAAP net loss to be between $40 million and $30 million. For the full year, we’re guiding to an improvement in our results from our previous range of $200 million to $275 million to our current outlook of $167 million to $142 million. This quarter you’ve gotten a glimpse of what our new marketplace bank can do, and we look forward to sharing more with you as we progress throughout the year. With that, let me open it up to Q&A.

Operator, Operator

Our first question comes from Henry Coffey with Wedbush. Please go ahead.

Henry Coffey, Analyst

Yes. Good afternoon, everyone. And congratulations to Scott, Tom, and Sameer on a job well done; I’m sure the entire team has put in a lot of effort. I have a couple of questions. First, to better understand the bank, can you explain what the portfolio consists of and how that portfolio is likely to change in size over time, excluding the consumer loan held for investment business?

Tom Casey, CFO

So, thanks, Henry. Just a couple of details: we did a schedule in the earnings release for your reference. On page nine, we broke out the assets of the bank and the holding company, so it’s a lot easier for you to see where the holding company earnings are going to be coming from. The total loans in the bank are just about $2.1 billion. Those are made up of about $324 million we had at the end of the quarter of consumer loans, and then the remaining were the commercial business that we acquired from Radius. Keep in mind that about $661 of that was from PPP loans. So, obviously, the balance sheet is slightly higher because of the gross up of the PPP loans. That’s the makeup of the earning assets. We do obviously have some securities that we also hold, about $151 million, and then we do have about $792 million in cash sitting in the bank.

Henry Coffey, Analyst

Should we expect the bank-related loans, and I'm separating all this from the LendingClub consumer business, to decline over time, or is that also going to be a growing business?

Tom Casey, CFO

So I think we’re going to see the fastest-growing piece of the business will be the consumer, because we don’t have anything in there right now. We just started building a portfolio. We expect that to be about 15% to 25% of our volumes per quarter, so that will grow faster than the...

Scott Sanborn, CEO

Origination volume of the consumer loan.

Tom Casey, CFO

That’s right. Of our origination volume. But all the portfolios are expected to grow some in 2021.

Henry Coffey, Analyst

And then, finally, and this is the question I get most frequently, as you look at balancing growth and integration costs and all these different moving parts that you’ve articulated for us, what is the path to GAAP profitability and how long does that take? How do you balance that against growth? Because, obviously, there’s a lot of growth we had from putting the loans on balance sheet versus selling them to somebody else?

Scott Sanborn, CEO

Yeah. So, hey, Henry, it’s Scott. I will start. Tom maybe you can come over the top with any details. What we’re trying to show with most of the prepared remarks and then in materials we shared separately is the model is highly profitable, right? It’s supported by a new revenue stream; for the same activities we were doing prior to the acquisition, we’re now generating significant revenue, and we’ve lowered our cost base substantially. So for us, there’s obviously a trade-off between the timing to profit versus the size of the eventual profits, and we’re going for the latter. Our in-period results are going to be impacted by loan retention, but that’s going to maximize our long-term profit. We’re building this business for the long term, we want to maximize that long-term profit. We feel really good about the credit we are generating and about the returns we’re going to get on this. We think that sets us up for long-term significant growth and profit.

Henry Coffey, Analyst

Why don’t you talk about the mix? Yeah. I’m sorry, go on, Tom.

Tom Casey, CFO

No. I was going to say, Henry, this is to call out some things I said in my prepared remarks. The $47 million loss; we did have a number of items in there, obviously, the non-recurring item of $9 million just related to the closing of the transaction. We had about $28 million of items related to CECL for loans being put on the books and deferral of the origination fee. You can see that a lot of that impact on the GAAP results were the result of the accounting convention, burning fees and having the book losses. We feel very good about the line of sight, but we’re going to continue to put loans on the books, which will continue to have this impact on our revenue and earnings because of the accounting convention. We indicated 15% to 25% is the right number for us right now. We think that’s a good balance between the growth and profitability. As Scott said, it’s really about how much profitability we think we can generate and how that will fuel the rest of our ambitions by having a very nice revenue stream coming at us.

Henry Coffey, Analyst

Great. And thank you, and congratulations on all the work that went into this process.

Scott Sanborn, CEO

Thanks.

Tom Casey, CFO

Thank you, Henry.

Operator, Operator

Our next question comes from Steven Kwok with KBW. Please go ahead.

Steven Kwok, Analyst

Hi. Good quarter and thanks for taking my questions. I guess, the first question I had was just around the strong originations growth and expected that to continue with raised guidance. Can you just talk about the competitive landscape? What are you seeing there and what’s the secret sauce behind the strong originations growth? Thanks.

Scott Sanborn, CEO

You got it. As we mentioned last quarter, in Q1, we really just reactivated the marketing channels for the first time. We’re in the process of going back out into the market and really optimizing and tuning on a channel-by-channel basis. We feel very good about how we’re positioned. The secret sauce, if you will, is both the data advantage I talked about, the fact that we have a combination of new customers we are bringing in, but also our existing member base that’s generating some of our volume. If you recall last year, we mentioned that we rebuilt our decision infrastructure, which has enabled us to really increase the speed and dynamism with which we can respond to signals we’re getting in the market as we go through the different marketing channels. In terms of the environment, I will say it is competitive. Basically, everyone who was out there pre-COVID is back. I don’t know if we are post-COVID yet, but they’re back in the current environment, and there are even some new players. We expect the environment to continue to be fairly intense, with a lot of people looking for yield, and consumer demand below pre-COVID levels. We think that’s temporary, and we’re certainly seeing spending start to recover. But within that framework of temporarily reduced consumer demand and a lot of competition, we believe we could not possibly be better positioned for all the reasons we articulated. We’re going to have a broader approval rate than the bank competition, higher earnings per loan, lower funding costs than the fintechs, and a big data advantage. Spreads right now and margins are a little wide, and credit is performing exceptionally well. So we feel good about our ability to compete in this market, which is why we were confident enough to increase the guidance.

Steven Kwok, Analyst

Great. And you mentioned about the increase in sales and marketing. How should we think about the expense base going forward? It’s relatively stable over the last three quarters; as we look ahead, if you can help guide us there? Thanks.

Scott Sanborn, CEO

Tom, do you want to take that?

Tom Casey, CFO

Yeah. So, Steven, you’re right; we took a big effort last year to resize our expense base. You see a little bit of a hiccup with the addition of Radius. I commented about $10 million; that was just for two months, remember. So it would be a little bit higher on a run rate basis. Expect that in the second quarter. But we feel like we’re at a point where we’ve got a lot of capacity to handle this growth. You’ll see us continue to invest in new capabilities. We feel like we’ve got a lot of scale that can be utilized as we ramp up our volume. So, we’re monitoring that, but we feel very good about our expense base right now, and we didn’t really lose many capabilities with our expense actions last year. We feel good about kind of where we’re headed for the rest of the year. We’ll have some growth in expenses, but I don’t think we should expect significant calls outs at this time.

Steven Kwok, Analyst

Thanks.

Scott Sanborn, CEO

To say another way, we preserved the capabilities to get back to the level of originations and drive the growth that we’re currently seeing. I guess the only other thing I’d say is, the revenue per origination is a number that’s going to be growing, right? That’s just another lens; our denominator will be changing there because we’re going to be able to generate more revenue from each loan that we’re producing.

Steven Kwok, Analyst

Got it. Good quarter, guys. Thanks.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Sameer Gokhale for any closing remarks.

Sameer Gokhale, Head of Investor Relations

Thank you very much, everyone, for joining us today. If you have any further questions, please contact the Investor Relations team, and we’ll be happy to assist you.

Operator, Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.