LendingClub headquarters in Silicon Valley.

Michael Vi/iStock Editorial via Getty Images

Michael Vi/iStock Editorial via Getty Images
This is my part II analysis on LendingClub (NYSE:LC). My previous article (part I) explains why LC is my top pick in the FinTech space. In this piece, I want to focus more deeply on its likely strategic direction as well as its capital allocation path. I am basing my views on public disclosures by LC’s management team in various forums (earnings calls, conferences, fire chats, etc.), but also leveraging my expertise in banking.
(All charts and extracts in this article are from LC’s Investor Relations website)
LC cut its teeth in the origination of unsecured lending as a pure FinTech operating a marketplace. It built and perfected its various models including marketing, credit risk, fraud, loan distribution, etc., over many years and has taken a leadership position in the unsecured lending space.
Becoming a bank in early 2021 has allowed it to monetize its marketplace platform. The benefits included a lower cost structure by eliminating Issuing Bank fees and replacing warehouse financing lines with low-cost deposits. More importantly, though, it allowed it to retain exceptionally profitable Prime loans on its balance sheet and thus creating an accrual interest income stream.
The following slide demonstrates the monetization of the platform:

LC Investor Relations

Monetising LC’s Platform (LC Investor Relations)

Monetising LC’s Platform (LC Investor Relations)
The numbers really speak for themselves. And the main driver for the incremental income is the stable interest income stream which is growing quite quickly. As highlighted in my prior article, LC is on the path to growing its unsecured lending balances from ~$2.35 billion at the end of Q1 2022 to as high as $4 billion at the end of 2022. If you factor in a net interest margin (“NIM”) of approximately 12.5% on these assets, that’s an incremental ~$210m net interest income in 2023 (conservatively assuming no further growth in unsecured loans).
Another point that investors need to be concerned with is understanding the impact of accounting for loan loss provisions (otherwise known as “CECL”). In the not-too-distant past, loan loss provisions were booked when incurred. Under the relatively new CECL regime, banks are required to provide for expected lifetime losses on their loans on inception (and reassessed every reporting period). This effectively means that expected losses are incurred for accounting purposes upfront but the income (including origination fees) is only recognized over the life of the loan. CECL has the potential to create additional (unhelpful) volatility where the macro environment changes rapidly. JP Morgan’s CEO Jamie Dimon explained this rather eloquently at a recent conference:
And so, anyway, you have a normal credit cycle, charge-offs will go up, we’ll still be earning money; CECL makes it very volatile. Like, I think I pointed out in Investor Day; we put up, in two quarters, so in the first quarter of 2020, the second quarter $15 billion of CECL. And then the next four quarters, we took it down. I mean, I don’t know what kind of accounting that is, I think it’s crazy. I don’t know who invents this shit, but we have to deal with it regardless.
The takeaway for LC investors is that loan loss provisions for the current portfolio are already embedded in GAAP numbers. This distorts the numbers somewhat and is complex to understand but importantly, it means that the accounting numbers are invariably conservative.
But let us examine the strategic direction and capital allocations in more detail.
Banking is all about decisions around capital allocation and management.
Clearly retaining unsecured credit on the platform is a no-brainer. As per my prior article, my estimate is that the ROE on retained loans is between 40% and 50%. So I expect LC, in the near term, to continue to grow the portfolio aggressively. The growth in unsecured is a function of origination volume as well as the percentage of loans retained on the balance sheet. Whilst it currently targets to retain between 20% and 25% of loan originations, LC can flex this higher if needed (say 30%) subject to capital constraints.
To fund this growth, LC needs capital. The current binding constraint is a leverage capital ratio of 11% ratio.
Currently, LC’s leverage ratio is a healthy 13.2%. Now if we assume LC generates organic capital of $200m per annum, this allows for incremental growth in loans of ~$1.8 billion per annum.
So if you ever asked yourself, why is LC not retaining more assets on its balance sheet? There is your answer. LC needs to keep a healthy buffer above its 11% leverage ratio (aside from maintaining sufficient volumes for a lively marketplace).
However, LC’s profit trajectory is up and to the right and so is its organic capital generation. If you assume $400m of capital generation per annum, then its incremental loan growth capacity becomes $3.6 billion all of a sudden, which is unlikely to be satisfied by the current origination level.
Currently, almost all of the organic capital is deployed towards growing the high-returning unsecured portfolio. I also suspect this is the reason why LC sold its Yacht portfolio as well as very slowly growing its auto refinance business – both being much lower return businesses. It also explains why it focuses on the capital-light deposits product as opposed to additional lending products.
In other words, LC is deploying all of its available capital towards its highest-returning assets. However, in the future, as it generates excess capital, it will need to deploy excess capital elsewhere.
So the next phase of its growth is all about deepening client relationships with additional products.
The anchor product is the unsecured lending product unlike many of the other digital banks which are deposit-led. This is a significant competitive advantage and an exceptionally high-value transfer from a customer perspective. This is plainly obvious from the high Net Promotor Score (80) and reviews on LC’s website.

LendingClub Website

LendingClub Reviews

LendingClub Reviews
I would recommend that readers skim through the review to get an appreciation of customers’ satisfaction with the service and product quality.
The next phase of the strategy has to be about further monetization of clients’ lifecycle as they borrow, save, spend and invest.
The near-term opportunity is the checking account and linking it to the unsecured credit acquisition model. The advantages are clear in terms of better visibility of clients’ cash flows and being able to make a better-informed credit decision. And especially in a rising rate environment, the margins on operating accounts are quite lucrative.
Additional lending products such as auto refinancing and mortgages are further secured lending opportunities, as well as savings accounts and wealth management products.
LC is in a unique position where its customer acquisition channel through unsecured lending is highly profitable from day 1. As such, there is a very little additional marginal cost in cross-selling other products and especially so, if the technology stack is completely automated, streamlined, and user-friendly.
In time, this allows LC to view customers’ profitability on a multi-product level, facilitate better credit decisions, and lower costs for customers. In other words, offer more competitive rates which in turn feed that flywheel of increased market share, data, credit decisions, and higher profitability.
If you believe that LC’s balance sheet in the future will comprise almost wholly of unsecured lending, I would argue that you are dead wrong.
LC has to diversify the balance sheet for various reasons. First and foremost, diversification is key to weathering any deep and prolonged downturns. It would also be seen as a negative by regulators and primarily the reason LC is currently subject to much higher regulatory capital ratios than other banks.
Secondly, as discussed above, LC is unlikely to be able to fully deploy organically generated capital in unsecured lending and still keep the marketplace model viable. The current growth in unsecured assets is from a low base, it is likely to grow more slowly in the future as earlier originated loans are repaid. That excess capital can be effectively deployed in other lending products that deliver lower returns but still deliver overall fantastic returns that are much higher than LC’s cost of capital.
LC generates capital-light fee income from its marketplace as well as ongoing servicing income, which is quite unique for a bank. The marketplace also provides LC with insights and feedback on what type of assets investors are seeking and allows it to take advantage of this information (e.g., pricing decisions with clients, gains on the sale of assets, etc.). More recently LC enhanced its automated loan auction platform (“LCX”) by allowing institutional investors to sell LendingClub loans directly to each other on the platform. This further enhances LC’s insight into investor behavior, preference, and price.
LC’s current asset mix is shown below:

Investor Relations

Asset Mix

Asset Mix
I expect its balance sheet to grow quite rapidly initially, driven by unsecured credit but then augmented by ramping up secured assets (auto refinance, mortgages, and student loans) as well as commercial loans.
In 2 to 3 years, on its current trajectory, its total assets could reach $8 billion to $10 billion comprising say $6 billion of unsecured lending, $2 billion of secured lending (auto and mortgages), and $2 billion of commercial loans and cash.
Given the exceptionally high net interest margins (“NIM”) and additional fee and servicing income from its marketplace, I expect LC’s profitability to grow exponentially.
In the near term, I fully expect LC to press the pedal to the metal on retaining unsecured loans on the balance sheet. This is an exceptionally profitable business and a no-brainer.
Later on, as it starts to generate excess capital beyond what it can reasonably deploy to unsecured lending – I expect it to ramp up other secured lending products such as auto refinance, student loans, and mortgages. These are not as profitable as unsecured lending but still provide solid returns with little incremental marginal cost.
Linking checking and savings accounts is already in the works and should enable better credit decision-making as well as deliver nice margins as interest rates rise.
The next phase of its strategy is all about monetizing the customers’ lifecycle as they borrow, spend, save and invest. This enables LC to create multiple and diversified income streams that include marketplace fees, servicing fees, unsecured and secured lending, debit/credit cards, deposit margins, and (probably much) later on wealth management fees.
LC is likely to grow the balance sheet very quickly. I expect it to double in two to three years led by growth in unsecured lending. Yes, it is a bank but with an exponential growth profile due to its wide moat in unsecured lending originations, marketplace, and digital-led approach.
In my next article (part III), I will provide my analysis of risks to the thesis as well as my view on how it will perform in the case of a recession, so stay tuned if of interest.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of LC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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