Earnings Call Transcript - LC Q2 2021

Operator, Operator

Good day, and welcome to the LendingClub Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Sameer Gulati, Investor Relations. Please go ahead.

Sameer Gulati, Investor Relations

Thank you, and good afternoon. Welcome to LendingClub’s second quarter 2021 earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, CEO; and Tom Casey, CFO. You can find the presentation accompanying our earnings release on the Investor Relations section of our website. 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 the benefits of our acquisition of Radius, 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 our most recent forms 10-K and 10-Q, each filed with the SEC as well as our subsequent filings made with the Securities and Exchange Commission, including our upcoming Form 10-Q. 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 as a result of new information or future events. And now I’d like to turn the call over to Scott.

Scott Sanborn, CEO

All right. Thank you, Sameer. Good afternoon, everybody. Thank you for joining us. Q2 reflects our first full quarter as a digital marketplace bank, and we significantly outperformed our expectations. Across the board, the actions we took as we re-entered the market drove better results on a faster timeline than we had anticipated. Notably, we achieved record profitability, which we expect to sustain and grow as our new recurring revenue stream of net interest income continues to build. In addition to the benefits received from our recently acquired digital bank, our Q2 profitability was driven in large part by revenue growth from our marketplace, combined with operating efficiencies across our platform. Revenue growth in the marketplace was driven by growth in originations, which were up 84% sequentially. We resumed marketing and returned to a more normalized credit posture, with a continued focus on higher quality issuance. The outperformance of our credit relative to our competitors set is driving strong investor demand, and we added several new banks and institutional investors to our platform. Banks, including LendingClub Bank, now make up more than half of our loan funding. During the quarter, we leaned into our competitive advantages to quickly tune our efforts to current market conditions and tap into the nascent recovery in consumer demand. I’d note that as the unsecured credit market is recovering, fintech is growing faster than the market, and we are growing faster than other fintechs. According to DVO1, which tracks market share data for personal loans, we have returned to market leadership. It’s worth highlighting that our sequential revenue growth of 93% outpaced originations growth during the quarter. This primarily reflects significant growth in our new recurring net interest income revenue stream, as we took advantage of our low-cost digital bank deposits and grew our loan portfolio. We expect revenue growth to continue to outpace originations growth as this income stream builds. Tom will provide details, but it’s important to note that as we invested in growing our loan portfolio to build this new revenue stream, we sacrificed about $54 million in potential earnings in the quarter. We did it because we expect holding loans to eventually generate three times the earnings compared to selling them; the near-term trade-off is more than worth it. As I mentioned, our strong revenue growth was combined with efficiency gains across the income statement. We improved our marketing efficiency by leveraging our marketplace model, which allows us to say yes to a broader range of customers, leveraging our data advantages to enhance our targeting, underwriting, and pricing models. These models are built on more than 150 billion cells of data and more than a decade of experience across over $65 billion in loans. We also optimized our application funnel and drove automated decision rates back to north of 70%. As a result, end-to-end funnel conversion was up significantly, reflecting improvements in offer rates, take rates, and issuance rates. Furthermore, we continue to focus on serving our large and loyal base of over 3.5 million members. We are attracting new members to our platform at an accelerating pace; a large portion of our loan volume continues to go to our existing customers, reflecting the expanding lifetime value we’re generating and the affinity created by offering seamless access to low-cost credit. Finally, and as I mentioned earlier, consumer demand also appears to be ticking back up, though currently remaining below pre-COVID levels. Taken together, we believe we have one of the lowest customer acquisition costs among our competitive set, which is a significant differentiator built on our unique advantages, including our larger loyal member base, our marketplace model, and our data supremacy. Along with improved marketing efficiency, we also had a substantial improvement in operating efficiency, reflecting actions we took over the last two years to streamline our expense base. Specifically, our fixed cost base now reflects the benefits of our business simplification initiatives in 2019, actions we took last year to further reduce our expenses, and efficiency gains from more recent technology investments in our servicing infrastructure. So, where do we go from here? As I said before, it is hard to imagine a better time to be growing a digital bank. We believe our actions over the past several years, our core capabilities, and the overall accelerated trend to digital banking have set us up well to win. We believe we can deliver sustained profit while investing in our future to bring to life a next-generation digital bank that will transform the experience and reimagine banking for our customers. I want to take a moment to thank our employees for their commitment to our customers, our company, and our mission. We would not have been able to achieve these great results without their dedication and hard work. So with that, I will turn it over to Tom for a more detailed discussion of our financial performance.

Tom Casey, CFO

Thank you, Scott. The speed of our transformation and the power of our business model was evident in Q2. We far outpaced our expectations as we started to hit an inflection point for earnings growth at LendingClub. For the second quarter of 2021, we reported record net income of $9 million and diluted EPS of $0.09 per share, as we accelerated our return to GAAP profitability. In Q2, originations were $2.7 billion, of which we sold $2.2 billion through our marketplace. We also retained $541 million of loans as we continue to build a new revenue stream by growing our highly profitable consumer loan portfolio. In Q2, revenues grew 93% sequentially on origination growth of 84%. As Scott mentioned, we expect revenue growth would outpace origination growth as we continue to grow our new stream of recurring interest income by building our consumer loan portfolio. Consumer loan balances grew 44% to $1.3 billion, while the total held for investment portfolio grew at 12% to $2.4 billion, reflecting some runoff of PPP loans. In the second quarter, total deposits grew to $2.5 billion, while deposit rates were in line with Q1 at 29 basis points. Non-interest income grew 81% sequentially, primarily due to increased marketplace loan sales, which more than doubled transaction fees to $114 million from $56 million last quarter. Gain on sales revenue also more than doubled to $19 million. Net interest income grew sequentially by 148% to $46 million, primarily reflecting growth in our personal loan portfolio, as the bank's net interest margin expanded from 3.3% to 5.51%. As you can see on Page 9 of the earnings release, this portfolio generates a very attractive interest rate with an average yield over 15%. We expect our personal loans to generate risk-adjusted margins of 78% over time as they season. However, accounting standards require us to recognize expected losses when we add them to the balance sheet, and then we recognize the interest income over the life of the loan. This is what Scott highlighted earlier in his comment, as the income from retaining consumer loans generates three times the profitability of marketplace loans. Due to this powerful benefit, we expect continued growth in this portfolio. We also generated significant positive leverage during Q2, as our revenue growth of 93% outpaced our non-interest expense growth of only 19%. Excluding marketing expenses, which are variable expenses and directly tied to origination volumes, our non-interest expense grew by only $10 million in Q1, which also captured a full quarter's expense from the bank acquisition that closed on February 1 of this year. Our ability to contain expense growth reflects the actions we took over two years ago to substantially increase our efficiency while enabling our infrastructures to scale as we grew. For example, in the second quarter, our revenue increased by $99 million, and our GAAP earnings improved by $56 million. We expect to continue to generate positive operating leverage, which will fund future investments in our infrastructure and capabilities. In Q2, we maintained our marketing efficiency, with marketing expenses of $35 million down 80% sequentially. As we continue to grow origination volumes by leveraging our best data advantage, our loyal member base, and our ability to leverage our predictive science and credit decision platforms, we drive higher conversion rates. During the quarter, we reported a non-cash credit loss provision of $35 million, primarily reflecting retention of $541 million in personal and auto repay loans on the balance sheet. There were minimum charge-offs in the second quarter, and we expect charge-offs to start to normalize gradually over the remainder of 2021 as loans typically season over nine months to 12 months. One additional item I wanted to highlight is that our digital bank generated net income of $40 million during the quarter, including a $12.5 million tax benefit primarily from reversing the valuation allowance on its deferred tax assets. As we generate taxable income at the bank, we expect to continue to utilize our net operating loss carryforward of approximately $160 million at the holding company to reduce cash taxes, which will also provide additional regulatory capital at the bank to support loan growth. The overall improvement in our current performance compared to pre-pandemic is significant. For example, in the third quarter of 2019, we produced our highest revenue quarter at $205 million on volumes of $3.3 billion. This past quarter, we delivered the same amount of revenue on nearly 20% less origination volume of $2.7 billion. And there’s a similar efficiency story regarding our expense base. Again, in the third quarter of 2019, we had expenses of $205 million, compared to $160 million last quarter, indicating a $45 million run rate. This reflects our efforts to improve our marketing efficiency and reduce our fixed costs, both of which strengthened our ability to continue to drive margin expansion and improved profitability. Now, let’s turn to our financial outlook. Our strong and sustainable results allow us to significantly raise our guidance. We are increasing our revenue for the year by a range of $240 million to $250 million and are projecting an increase in GAAP net income. Our guidance assumes the economy will continue to grow for the remainder of the year, albeit at a slower rate. We realize there are significant uncertainties due to the ongoing developments with the COVID virus and impacts of government actions. Our outlook also reflects typical seasonality with Q4 originations reflecting seasonal pressure compared to the third quarter. Our guidance also incorporates expectations for increased investments in marketing, loan and deposit growth, infrastructure, and technology investments. Specifically for Q3, we expect to generate revenue of $215 million to $230 million on originations of $2.8 billion to $3 billion. We’re also estimating net income to be between $10 million and $15 million. For the full year, we’re raising our origination guidance by more than 40% to a range of $9.8 billion to $10.2 billion. We’re also raising our revenue expectations for the full year by more than 45% to a range of $750 million to $780 million. We expect to maintain positive GAAP net income over the second half of the year. Our guidance implies a range of $25 million to $35 million of GAAP net income. One thing to note is that our GAAP net income guidance assumes a more normalized tax rate of approximately 15%. We’re very happy to share our outlook as this has been the product of years of hard work to shift our business model to provide profitability and sustainable growth for years to come.

Operator, Operator

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

Henry Coffey, Analyst

Let me be a little exuberant here. This is amazing. This is a great accomplishment. So congratulations. What I’m looking at the numbers, I really have – I really have three sets of questions. So please bear with me. Your origination fee or your – to volume increased relative to the first quarter, your overhead as a percentage of originations dropped, basically from 9% to 6%. And the yield on the LendingClub loans held for investment at the bank jumped from 13.85% to 15% in the quarter. So, all of the key profitability metrics improved. I was wondering if you could give some insight; give us some insight into the improvement in origination-related fees and the improvement in yields on the loans held on balance sheet.

Scott Sanborn, CEO

Thanks, Henry. Indeed, those metrics you point to are pretty much across the board, as we indicate in the prepared remarks, pretty much all actions ended up in delivering stronger results, and in fact, more quickly than we anticipated. A ton of alternative to you to talk a little bit about those couple drivers.

Tom Casey, CFO

Yes, so Henry, a couple of things. First, on the origination fees, this is a product of all of the work we did in 2022, with our data and decision science to understand price elasticity, and we were able to generate some additional fees as well as a mix. We also expanded, in all of our marketing channels and expanded our reach, and so you’re seeing the origination fee grow accordingly.

Henry Coffey, Analyst

And still below what your other public competitor, that’s in this business, but that’s just a side observation.

Scott Sanborn, CEO

So on the second one, on the overhead, again, not to overstate it, but it’s throughout the numbers, you’re seeing productivity come through just the operating leverage of getting that volume up and the scale that we have coming through. We’ve done a lot of hard work resizing the business over the last few years, and you’re seeing that now with the growth in volumes and revenues. But keep in mind also the revenue is also, we have our new revenue stream coming with the net interest income, which will further create more operating leverage for the company. And then lastly, on the yield, the yield on the consumer loans is up at 15% this quarter. It’s really reflecting just the full year before assuming the full quarter of ownership as we wrapped up our personal loans, adding another over $500 million to the portfolio. It’s just a mix issue, Henry.

Henry Coffey, Analyst

Then again, the second question, can you give again the reserve level that you’re putting up relative to your losses? Is multiple, but that’s all this oddities of CECL. Can you give us some insight into how the LendingClub combined consumer loan portfolio is performing?

Tom Casey, CFO

Yes, as Scott mentioned in his prepared remarks, the entire book of business is performing extremely well. We’re very pleased with how our loans have performed regarding the loans on our books. We’ve only been building that portfolio for two quarters now. We really have not seen any charge-offs to speak of. However, we have in my comments mentioned that CECL will start to mature over the next nine to twelve months from origination. That’s typically where we see charge-offs come in. So the next couple of quarters you’ll start to see a little bit more color on the pattern of the charge-offs. But overall, we’re feeling very good about the credit performance, not just the recent vintages, but frankly for the multiple vintages that are still outstanding.

Henry Coffey, Analyst

And then my third question, this is more for Scott. But obviously for both of you, what we’re seeing today is the advantage of LendingClub joining up with the bank. But my real question – I think the next opportunity, the one we’re going to see, sort of out there is the bank joining up with LendingClub. So, can you give us some insight, besides getting great loans on their books? Can you give us some thoughts about how and in the future, the LendingClub side of the business will learn to work with the banks and think you might offer club members ways you might enhance relationships between borrowers and depositors and certain product sets? It’s pretty much an open opportunity.

Scott Sanborn, CEO

Yes, thanks, Henry. You’re right. I think we view this quarter as really demonstrating the advantages LendingClub brought to the table, right with our data, our membership base, and kind of data science capabilities – adding in the bank to generate a new revenue stream, and lower cost of capital. Where we’re getting started is, obviously, this particular financial engine, because this is what’s going to drive the profit of the business. We wanted to get this part of the business get that momentum going. As we indicated, where we expected to get here, the velocity at which we got here was faster than we anticipated. When we look ahead, this is really just phase one. Taking this engine we’ve got, which is the ability to acquire really satisfied customers at scale, profitably. And take that to do more for those customers, we shared in a previous call that 80% of customers say they want to do more with us. That’s the next phase. We’ve got the momentum building here; the next thing we’ll turn to is the auto business within the bank. And maybe Tom, we can plan on talking a little bit more about that next quarter. That’ll be the next business that we want to take the combination of the two. To your point, the piece after that, maybe something for us to talk about after Q4 earnings would be, what’s the role of the bank and really the award-winning member-checking product that we’ve acquired with Radius, how we see that fitting in. But the basic story is, we see that as a real engagement platform for us. It’s a way rather than people coming back once every few years when they need access to low-cost credit. We have a way to be communicating with and adding value to our members much more dynamically and much more frequently, generating more data to inform and give us insight about what they need and inform our underwriting. I’d also offer more services and do it in a way that’s really aligned with the brand, right? Right now we’re helping people with lending. But the goal here is to move wider in breadth and help them with their spending and help them with their savings.

Henry Coffey, Analyst

Well, congratulations on a job well done. So thank you all.

Operator, Operator

The next question comes from Giuliano Bologna with Compass Point. Please go ahead.

Giuliano Bologna, Analyst

Well, I’ll echo what Henry just said, congratulations on an incredible quarter. Then jumping in, I’d be curious to get your perspective on some of the impacts that drove the quarter. Obviously, origination volumes were significant above expectations. I’d be curious if there are any channels or different products within the mix or if there are any credit tiers that outperformed or if it was broad-based across the board in terms of generating additional volumes.

Scott Sanborn, CEO

Yes, thanks. It was really one thing we didn’t talk much about. But we did talk about it last year when we pulled back on volume. We were in, let’s call it, capital preservation mode. We indicated to you all that we were taking this opportunity to be investing in our infrastructure, both our servicing infrastructure, which we’re getting some of the efficiencies and loan performance benefits of today, but also our credit decisioning infrastructure. What that has allowed us to do is move more. It’s kind of simplistic to say, hey, we just went back to marketing; it doesn’t just turn channels on and they work great. You’ve got to tune things, right, tune your offer, tune pricing. With the infrastructure we put in place, we’re able to do it much more quickly. It’s really a combination of kind of everything working, as we mentioned, consumer demand well below pre-COVID, picked back up. Our take rate and our issuance rate picked back up to drive funnel conversion, and investor demand for loans was up, which drove pricing up there. So we really saw across the board in all key metrics.

Giuliano Bologna, Analyst

That’s great. And going back to, we previously guided to retaining somewhere between 15% to 25% of loans. The previous guidance also included a relatively worse net income results from 2021. I’d be curious, now that you’re originating a larger volume earlier and retaining more loans, how the kind of capital generation to loan your ability to retain 15% to 25% of originations will unfold, because you’re obviously generating more capital than you expected, and you’ll be in a better capital position, and you’re taking on more loans faster than you’d originally indicated to the market. So, I’m kind of curious how those two play together and if there’s any change to that guidance or if there’s any room to the upside over time there?

Scott Sanborn, CEO

Yes, so a couple of things to capture there is that we use the 15% to 25%. We think it’s a good range to keep a nice healthy marketplace but also participate in that revenue stream and grow it. The way to think about it is, as you think about growing originations like we did this quarter, you saw us actually increase the amount of purchases we did. So, we did about right about 20% this quarter. To the extent volumes go up, that actually funds a lot of the capital needed for the provisioning. The capital is needed. What you saw this quarter, and I highlighted in my remarks, is the bank is generating GAAP net income as well. So, it’s building its own capital and starting to be able to support growth. And then also, with becoming GAAP profitable, we are also starting to benefit from the utilization of our net operating loss; I mentioned about $160 million. So that all starts to bring additional capital into the bank to support the ongoing growth of assets. We still think that’s a good number 15% to 25%, and we think there’s sufficient capital generation within the volumes, as well as some of the things I mentioned on the call, and we feel very good about our ability to flex up or flex down depending on the environment.

Giuliano Bologna, Analyst

That’s great. A little more on the funding side, obviously, to grow the deposit franchise. I’d be curious, like I said, what I’d be curious about is how much you think you can scale that positive franchise or how fast you can scale it. And then along similar lines, I’m kind of curious if there’s been any difference in the mix of marketplace loan buyers on the other side of the platform. And if there’s any change in demand on that sort of platform?

Scott Sanborn, CEO

I’ll maybe start on the investor side. Tom, do you want to talk about the liability? On the investor side, we’ve seen strong investor demand across the spectrum of investor types. As we mentioned, we’ve added year-to-date multiple asset managers and multiple banks. We talked last quarter about how, as a whole, the asset class held up really well last year, and LendingClub specifically held up better than the competitive set. I think one of the things we perhaps didn’t anticipate was that our status as a bank does help us in multiple ways. One for banks evaluating the asset, they know we’re held to the same standard as they are from a regulatory perspective. Secondly, we’re eating our own cooking, which gives people a lot of confidence in our view of the importance of credit quality. So, those things make rational sense, but until you see them in action, we really saw this quarter.

Tom Casey, CFO

Yes, I’d just touch on the deposit side. I think we commented earlier, when we closed Radius, we actually got a lot more deposits than we had anticipated. We’ve been putting some of that cash to work. We did see growth for the quarter in interest-bearing deposits. I think there’s a story that we’ll start talking about regarding our deposit generation capability to fund loans. It’s quite important for everyone to understand that, unlike what you may be seeing in other banks, we are actually growing our loans by 12% total. Our name is expanding 200 basis points to 5.5%. That is a unique characteristic of our model, which is being able to originate loans and grow this income stream at today’s very low-cost deposits. Even as deposits may increase, the margin we’re getting on our new loan growth is well in excess of that, and this throws off a very nice return that will drive expanding ROEs.

Giuliano Bologna, Analyst

That’s great. I appreciate your time, and congratulations on a great quarter. I’ll jump back in the queue now.

Operator, Operator

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

Steven Kwok, Analyst

Hi guys, I’d like to echo my comments and congratulations on a great quarter as well. Scott, quickly around the origination side, if I just take the midpoint of your guidance, that would imply about $2.9 billion hope for the next two quarters, which essentially puts you back at 2019 fundraise level. Just wondering, as we think about going forward, how fast can you grow off of that base?

Tom Casey, CFO

Well, Steven, this is Tom. Obviously, we are trying to factor in the environment. We are still trying to attract the path of the virus and what the implications will be for consumer spending and the economy at large. We think that this asset class, as Scott mentioned in his comment, is growing quite quickly, and fintechs are growing the fastest. We’re not going to give specific guidance on how fast we think we can grow, but I can give an indication of continued sequential growth in the back half of the year. We acknowledge that we have to be thoughtful about the dynamics in the environment. We think there’s more upside and more demand, and we think we’re well positioned to capture the share that we’ve demonstrated in the second quarter if demand improves.

Scott Sanborn, CEO

Yes, maybe just add a little color on what’s happening underneath the covers. One macro industry and one specific to LendingClub. Within the industry, given the state of consumer balance sheets, government stimulus, all those pieces, the credit card consolidation part of the business, which has been our major loan use case, that demand temporarily is down more significantly than other use cases. Correspondingly, we’ve seen growth in other use cases, home improvement loans, major purchases, which have taken off again. That’s one of the things happening at an industry level, and we don’t expect that to be durable. As the economy reopens, you’re already seeing many categories that have been lagging in spending take off again, credit card spending did start to pick back up. We think that will drive demand. The important thing to point out is, unlike the model prior to the acquisition, we’re now able to grow revenue faster than we’re growing loan volume, which is an important thing to think about as you’re looking ahead.

Steven Kwok, Analyst

Got it. And just to follow up around the consumer side, as stimulus wears off, are you starting to see a bit of a pent-up demand and the need for your loans?

Scott Sanborn, CEO

Yes, I think that’s right. As we mentioned this quarter, it’s hard to read. Getting a perfect view is hard because there are so many dynamic things going on. But yes, we are seeing a tick up in consumer demand. We saw that quarter-over-quarter, and we do think it’s because as the economy reopens, people resume spending in other categories, and that’s driving demand. The important point is that, unlike the model prior to the acquisition, we’re now able to grow revenue faster than we’re growing loan volume; that’s an important thing to think about as you’re looking ahead.

Steven Kwok, Analyst

Got it? Thanks. And thanks for taking the time to answer my questions and congrats on the quarter.

Scott Sanborn, CEO

Thanks.

Operator, Operator

Thanks. The next question comes from John Rowan with Janney. Please go ahead.

John Rowan, Analyst

Good evening, guys.

Scott Sanborn, CEO

Hi, John.

John Rowan, Analyst

I will echo everyone’s sentiment on the good quarter. But just a couple of housekeeping-ish type questions. The allowance build in the bank was quite significant sequentially. Are we at the right level of allowances going forward to where we should see that percentage hold steady with growth?

Scott Sanborn, CEO

Yes, I think two things are happening, John. One is the mix will change slightly quarter-to-quarter. So each type of loan gets a slightly different index. But that’s just a little bit of mix. The other thing you’ll see is that it will be impacted by the accretion because remember that CECL is a present value number on the day of origination. So you’ve got those types of dynamics. I don’t think those will be that material to the number. As you see the portfolio starting to ensure, I think that number will stabilize a little bit, but obviously, it grew quite a bit in an absolute dollar amount, reflecting that we’ve retained about $200 million more loans in the quarter.

John Rowan, Analyst

Okay. And Tom, just to clarify, you said that the guidance in the back half of the year reflects a normalized tax rate of 15%. I’m just curious, why taxes when you have a $160 million NOL, or is that 15% still eating away at the NOL between what would be 15% and maybe a more normalized 20%-ish rate?

Tom Casey, CFO

Now, unfortunately, it’s tax driven. Some states have passed the ability to utilize and it will carry forward. So you’re seeing the impact of that in the financials that we’re projecting for the rest of the year.

John Rowan, Analyst

So, when the NOL is exhausted, what will the tax rate be?

Tom Casey, CFO

We think it’s probably somewhere in the 25%-27% range. We’ll obviously make sure we understand that and get a better view once we start getting enough of that. But I’ll tell you that it weighs over $160 million NOLs; so it’s about an effective rate of around 28% is about $550 million of earnings. We have a ways to go, but we don’t expect to be paying a lot of cash taxes in the near term or even medium term.

John Rowan, Analyst

Okay, thank you.

Operator, Operator

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

Sameer Gulati, Investor Relations

Okay, great. Thank you, Tom. And thank you all for joining us today. If you have any questions, please contact Investor Relations 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.