LendingClub Corporation
Q2 2016 Earnings Call Transcript

Published: 9 Aug 2016

[Operator:]

Good afternoon and welcome to the LendingClub Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to James Samford, Head of Investor Relations. Please go ahead.

[James Samford:]

Thank you and good afternoon. Welcome to LendingClub’s second quarter 2016 earnings conference call. Joining me today to talk about our results are Scott Sanborn; and Carrie Dolan. And we're also joined by Brad Coleman, who was recently named LendingClub's Interim CFO. The format for today's call will include a business review by Scott, followed by a review of the financials and outlook by Carrie. We will then open up the call to questions. Before we get started I’d like to remind everyone that our remarks today will include forward-looking statements and the 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, the related slide presentation on our Investor Relations website and our Form 10-K filed with the SEC on February 22, 2016. 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. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release. The press release and accompanying investor presentation are available on the website at ir.lendingclub.com. Unless specifically stated, all references to this quarter relate to the second quarter of 2016 and all year-over-year comments are comparison to the second quarter in the prior year. And now, I’d like to turn the call over to Scott Sanborn.

[Scott Sanborn:]

Thank you, James. Good afternoon, everyone. Q2 was a busy quarter and the good thing is that it is now behind us. We have accomplished quite a bit since the events of May 9th. Over the past three months, we’ve been focused on re-engaging our investor and we are very pleased with our progress to-date. We believe we've stabilized the investor base, with 15 of our top 20 investors now back on the platform, albeit at lower investment levels. We took steps to enhance asset quality and investor returns by increasing rates and tightening credit. We welcomed the first 40 Act Fund to our investor mix, which in addition to the resilient retail base demonstrates the continued attractiveness of Lending Club to individual investors. We witnessed strong demand and pricing execution and a securitization brought to market by Jefferies, who has completed their diligence and have resumed purchasing. We conducted a thorough review of our internal controls and business processes and are now working on a number of initiatives to further strengthen these controls. We added some tremendous talent to the executive team, including Sameer Gulati joining from McKinsey as Chief Operating Officer in May, and in June, Patrick Dunne joined from Black Rock as our Chief Capital Officer. We’re also excited to announce that Tim Mayopoulos, the President and CEO of Fannie Mae has joined our Board. Given all that we have accomplished in this short time period, we feel confident about our future and believe we're on track for a strong year in 2017. That being said, we still have a lot of work ahead in the coming quarters. Before we get into details from Carrie on second quarter financial results and our outlook, I’d like to provide more color on the actions we are taking to increase the supply of capital, boost asset performance and strengthen internal controls. Starting first on the supply of capital. Following May 9th, we faced a significant disruption in our capital supply and quickly took the following steps. First, we decreased marketing spend to slow the pace of demand from borrowers to match investor appetite. Second, we focused significant internal and external resources on satisfying investor diligence requests that are the prerequisites for their return to the platform. Third, we developed an investor incentive program targeting all investor types and designed to accelerate investments. Incentives were offered in tiers with higher incentives for larger volume commitments. These programs are structured to conclude at the end of August. Fourth, as previously mentioned, we increased rates and tightened credit to further enhance the attractiveness of the assets while maintaining the value of the borrowers. Fifth, in support of our capital raising efforts, we hired a Chief Capital Officer and more recently a new Head of Institutional that we will be naming shortly. And finally, we leveraged our considerable balance sheet opportunistically to bridge what we recognized is a temporary imbalance between supply and demand. In Q2, we purchased $135 million in loans and then resold the majority to investors. This allowed us to fulfill borrower demand without any loan expirations or borrower disappointments. As we have emphasized, a key strength of our model is the diversity of investors that come to Lending Club for attractive risk-adjusted returns. We divide investors into four separate categories

[Carrie Dolan:]

Thanks, Scott. Before I review our financial results, I first like to say thank you to Scott for his kind remarks. I’m extremely proud of this company. Since I joined six years ago, we have lowered the cost of credit for over 1 million borrowers through our marketplace, while also providing investors with attractive risk-adjusted returns. We have done this with a capital-light model and by leveraging technology. This business model works. I would like to acknowledge and thank the over 1,500 employees at Lending Club for their hard work in building this company, with a special thanks for the dedication over the last three months. I believe this company is in great hands, and now that investors are re-engaging with the platform, I'm excited to begin my next chapter. Thank you for an incredible six years. With that, let’s turn to the results and the outlook. As Scott shared, this quarter started off strong in April, then following the announcement we made on May 9th, many investors initially paused or reduced their investment activity. We were able to quickly respond to decrease - to the decrease in investor capital by cutting back on our marketing spend to more closely match borrower loan applications with investor supply. At the same time, we created an investor incentive program to help clear borrower loan applications in our pipeline and to accelerate diligence and subsequent capital flows. We are pleased with the progress we are making in reengaging investors and the momentum that has carried us into the third quarter. Today, I’ll start with our second quarter results and then discuss our guidance before opening the call up for questions. As a reminder, all year-over-year comments are comparisons to the second quarter in the prior year, and all operating expenses discussed exclude stock-based compensation, depreciation and amortization. With that, let’s turn to the results. Total originations in the second quarter were $1.96 billion, an increase of 2% compared to last year. The slower origination growth was due to the slowdown in investor capital that occurred post-May 9th. Roughly 51% of the second quarter volume was originated prior to May 9th, which represented 42% of the quarter in terms of calendar days. Operating revenue in the first quarter was $102.4 million, up 6.5% year-over-year. The slower operating revenue growth was mainly driven by the pace of originations and also includes two unusual items

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from James Faucette of Morgan Stanley.

[James Faucette:]

Thanks very much. I had a couple of questions. Carrie, you touched a little bit about expenses remaining a bit elevated through the rest of the year, how much of this elevated expense would you continue to characterize perhaps as unusual as we go through the rest of the year?

[Carrie Dolan:]

Yeah, so we do anticipate kind of the unusual expenses that we’ve called out to fall probably through the end of the year down maybe 80% or so, what’s still to be really determined kind of as we give further guidance as what that run rate going forward will be, we have spent quite a bit of time taking a look at our compliance and legal and our support organizations and we’ve made a number of changes over the last couple of years, but we want to make sure going forward that we are continuing to invest and have that stage correctly. And so that is work that’s currently underway that will form that cost structure.

[James Faucette:]

Got it. And then you mentioned I think in the press release perhaps that 15 of the top 20 investors were back on the platform, can you give us some sense of their magnitude now versus before? And how much are you having to incent or give price breaks to these investors?

[Scott Sanborn:]

So the level of investment varies pretty much. I would say as a whole in general they are lower levels than pre-Mother's Day, although as I noted they are all exceptions to that and we do have several who are actually larger than prior levels. Incentives were useful for us in kick starting the platform activity post Mother's Day. But we do anticipate that we will have those substantially ended by the end of this quarter in fact these incentives were volume based and for smaller volume investors they have already ended as of July and those investors have without exception have continued their purchase activity into August.

[James Faucette:]

Got it, thank you very much. And just wrap up for me, any update on SEC or DOJ investigations and time lines around those that have been communicated to you?

[Scott Sanborn:]

Yeah. There is no new news to report there.

[James Faucette:]

Okay, thank you.

[Operator:]

And our next question will come from Heath Terry of Goldman Sachs.

[Heath Terry:]

Great, thanks. I was wondering if you could give us a sense as you look to establish more stable funding for the platform. Can you give us an idea of sort of what are your strategy for that could go longer term I realize a lot what you are dealing with right now is more sort of the immediate needs of the company. But as you think about what Lending Club could look like on the other side of this is there a real change to the funding model?

[Scott Sanborn:]

So to your point our immediate focus has been on reengaging with our preexisting investors and that’s kind of been our primary focus and as noted we feel like we are making very good progress there. Going forward we are exploring what - adding some additional sources and or structures of capital to increase resiliency and diversity and that would include committed capital that we think might be a beneficial addition to our overall mix. Now that will come at a cost having a committed capital out there. So we are being thoughtful about the size and scale of that, but that’s absolutely something we will be exploring actively once we’ve got our preexisting investors fully reengaged.

[Heath Terry:]

Got it, thank you.

[Operator:]

Next we have a question from Brad Berning of Craig Hallum.

[Brad Berning:]

Good afternoon. Can you talk a little bit more on the expense side of more specifically what expenses are going to be more likely in the fourth quarter versus the third quarter? Can you talk about the magnitude of expenses in the third quarter that you think will go away, just to help us to think through more of the second half of the year on the expense side?

[Carrie Dolan:]

Yeah, so the various buckets we talked about investor incentives we gave guidance specifically that kind of if you take a look at overall volume we’re anticipating those to be somewhere between 75 and 125 basis points, kind of across volume that today is netted against revenue, of the remaining expenses that were unusual obviously we had employee related severance cost. Those were definitely one time that we were not anticipating repeating that. The expenses related to legal and due diligence and the reviews, those are things where we’re continuing to due diligence, we're continuing to use outside consultants to help with a number of those pieces. Obviously, that is then work that is over time, and we're anticipating that into the third and to the fourth quarter. And as I mentioned, kind of in the first question, I think on a relative basis with these particular expenses that modeling them coming down to maybe kind of roughly 80% - down 80% from the current levels by year-end would be a reasonable assumption at this stage.

[Brad Berning:]

And then just a follow-up, I know some other investors have been asking this already. And just could you walk us through the cadence more on a month-by-month basis, so we can all be in one place and understand a little bit better how June, July recovered a little bit? And on the volumes just to help us understand kind of how things have been going on the recovery side on the volumes?

[Carrie Dolan:]

So on volumes, we do have - we did talk about that many investors paused initially after May 9th. And so certainly the volume or the momentum have increased more in June certainly than it did in May. And we’re seeing even from June into kind of the momentum continuing. And it was really based on kind of the various investor types in terms of how fast that momentum change. We do have - we did say that roughly 51% of the volume was pre-Mother’s Day, so you can get some sort of sense with that latter half kind of what that look like. And we’re not certainly breaking it out for May and June, but certainly June was a heavier month than May.

[Brad Berning:]

Understood, I’ll get back in queue. Thank you.

[Operator:]

And next, we have a question from Mark May of Citi.

[Mark May:]

Thank you. Just a couple on the incentives. Can you just remind us, I’m sorry if I missed this already, whether that's booked on the P&L? And did you mention what portion of the originations in the quarter were incentivized? And kind of what gives you comfort in terms of forecasting the origination volumes as you reduce or eliminate these incentives? And I had a follow-up, if I could. Thanks.

[Carrie Dolan:]

Sure, I’ll start with the expenses. So the actual incentives are booked as a net revenue. So we had $14 million essentially that reduced revenue based on this. And we did say that - I said in my comments that really there are roughly 51% of the volume for the quarter was before Mother's Day. And so essentially that 49% included incentives of that $14 million, which works out to roughly the 145. Going into the third quarter, Mark, we think that incentives across our entire volume will be somewhere between 75 to 125 basis points. We structurally putting these incentive programs earlier. So we have - we feel we have very good visibility on how they’re structured and the tiers. So for example, if an investor came back earlier with high dollars, they got a higher percentage or if they bought inventory that was a little more scarce, they got a higher percentage, et cetera. And these in programs that are designed to run through the end of July and also at the end of August.

[Mark May:]

And you talked about quickly lowering the marketing spend. But if I calculating it correctly, kind of the marketing efficiency on an origination volume basis is continuing to go down. I guess I’m just trying to understand, maybe a question for Scott, given how close he is to the marketing side is - what’s happening on kind of like-for-like basis in terms of the marketing efficiency when you start to take out some of the noise that you’ve seen in the last quarter? And kind of what is your expectation going forward? Do you think we’ll see a stabilization in marketing efficiency when we look out over the next 6 to 12 months?

[Scott Sanborn:]

Yeah, so Q2 was - there was quite a bit of noise in there, which makes it a little harder to read. I think Carrie indicated there is a number of expenses in the sales and marketing line that actually are not related to borrower acquisition those include advisory fees for capital raising severance costs and all of that. So I think when we - Carrie guide me a little bit how we want to talk going forward I would say…

[Carrie Dolan:]

Yeah we were without the unusual expenses what I just mentioned was we were 2.28% in sales and marketing, which was down 7 basis points sequentially. Certainly both second quarter and third quarter tend to be our seasonably more favorable quarters relative to kind of first and fourth quarter. So I think that you would certainly want to take that into account in terms of the momentum. I think that kind of going forward the other thing we can certainly talk about is that the environment currently in terms of how we’re looking at conversion. So one of the things is that we adjust rates and certainly adjust credit that has an impacted well which can be a little bit of a headwind depending on how much we cut. So I think there is momentum with seasonal timeframe into the third quarter, but also we’ve made some additional cuts as well.

[Operator:]

And our next question comes from Eric Wasserstorm of Guggenheim Securities.

[Eric Wasserstorm:]

Thanks very much. Maybe just a follow-up on some of the questions that were just raised, can you help me understand what it is that give you conviction in the banks returning to invest in loans at the same degree as they previously were particularly ex incentives. I mean it looks like I know on a percentage basis to decline quarter to quarter wasn’t that big, but on a dollar basis it looks like it roughly halved. So how is that ground - how are you confident that that ground is regained so quickly?

[Scott Sanborn:]

Yeah so I think an important distinction for the banks is maybe I didn’t give - I can give a little more color than what I said in the prepared remarks is that the banks have not been as motivated by the incentives. They have very clear and quite lengthy diligence requirements that have been articulated to us that we are working through. So unlike let’s say some of the third party funds or managed accounts that were able to respond quickly and see the economic benefit available to them. The banks just have a longer process they need to go through their internal risk framework and decision making as well as vis-à-vis their regulators. I’d say what gives us confidence is that we’ve got a quite clear working plan with the banks meaning we have their diligence lifts, we are making very good progress at taking through them, we’ve got timelines that we’ve agreed to in terms of what we deliver by when and what needs to happen on their side and as I indicated we’ve got many banks back already buying today. And it probably wouldn’t surprise you here that sort of the larger the institution, the longer that process is going to take.

[Eric Wasserstorm:]

Yeah no I’m sure that’s true. And just a follow-up on that last point Scott, once an institution overcomes the hurdle of re-accomplishing diligence why not return to their prior level of investment if one bad loan is as bad as 10 bad loans right, so what prevents them from buying at the previous level?

[Scott Sanborn:]

Yeah so I think with banks that’s a reasonable expectation for us that it’s basically we’ve got to meet the requirements full stop. I think people are exhibiting right now a desire to just kind of test the pipes a little bit and ease back into it, but we are cautiously optimistic that once we have cleared all of these questions that we will be able to get back to where we were it’s just a question of course of time. And that’s again a little than the third party funds who they’ve got to raise capital on their own so they have a different set of who they need to go through with in order to assign additional funds.

[Eric Wasserstorm:]

Thanks for the explanation.

[Operator:]

And the next question comes from Bob Ramsay of FBR.

[Bob Ramsay:]

Hey, good evening. Just wondering it looks like you guys sort of hold before year guidance as we think about the fourth quarter with similar origination volumes with no severance, with no or very low incentives. Are you guys back at a point where you’re adjusted EBITDA positive in the fourth quarter?

[Carrie Dolan:]

As I mentioned with the third quarter we did provide a bit more range in both revenue and EBITDA, I think our confidence about investors reengaging is sound, but there is still a number of pieces of in terms of how we are working to satisfy diligence, what we are doing internally in terms of kind of bills and so forth. That leaves a little bit less kind of certainty to the numbers. So at this point - and I also mentioned that we are looking at other types of investor structures that actually could have some sort of investor acquisition cost to them. I think that one of the things when we look back at this experience and certainly over the last couple of years we’ve talked about being both kind of neither supply nor demand constrained. And so on the capital side of the business, the actual cost of acquiring investors has been really low to almost zero. And structurally going forward if we know that we have more certainty in that investor side of the business, I think that we definitely would want to structurally began to think about changes like that and Scott mentioned that. So to the extent that those types of things or those types of arrangements or I think that we put into place later this year that would also introduce a level of variability. So while we feel very much like we are healing and moving out we at this stage felt confident about one quarter out. We - looking at doing annual guidance again would be something that we would be thinking about for next quarter.

[Bob Ramsay:]

Okay. And I guess maybe thinking a little further out and at this level of originations the level in the second quarter at a level you’re expecting at third and fourth, when you get through all of the noise is this a level you expect to be able to be EBITDA positive?

[Carrie Dolan:]

I’m sorry, what’s just the last part again?

[Bob Ramsay:]

Yeah. Can you generate positive adjusted EBITDA at this level of originations once you get through all the noise?

[Carrie Dolan:]

So we have talked in the past about the kind of variability in the model and having extreme amount of leverage. And so to the extent that we wanted to move to EBITDA positive it’s not based on a volume level and I think I have shared this in the past that even several years ago $1 billion of origination we were EBITDA positive. We actually - when we made our recent job elimination we actually did very little in for example our technology engineering area and our focus on wanting to invest in the feature and make sure that we have kind of the infrastructure for that growth is a trade-off that we made. So we certainly are focused on moving back to be EBITDA positive and I wanted to make sure that restructure and think about kind of doing that on a relatively quick basis. But at least at this point we’re not giving a sense of when that quarter might turn. But it certainly it’s the focus and with the caveat that we do recognize that we have a bit of a higher expense base based on some of these unusual expense and also a higher investment in our technology team.

[Bob Ramsay:]

Okay, fair enough. Last question and then I’ll hop out. But I know you said Carrie I guess you had given sort of you noticed early this year, I’m just curious when the firm engaged, the outside recruiting firm to work on the replacement process and what the timeline looks like from here with that?

[Carrie Dolan:]

Specifically we are not sharing the specifics of when we engage the retain firm. Scott do you want to talk a little bit about the process?

[Scott Sanborn:]

Yeah, I would say we are very encouraged by the level of candidates that we are seeing, I think is evidenced by some of the key hires we’ve made with Patrick Dunne and Tim Mayopoulos on the Board. We’ve been really very pleased with who we’ve got in motion, so we do expect in due course to be making an announcement.

[Bob Ramsay:]

Okay, thank you.

[Operator:]

And next, we have a question from Stephen Ju of Credit Suisse.

[Stephen Ju:]

Thanks. So Scott, investors are probably more aware of the events of May 9th versus borrowers. And I’m wondering, if you’re seeing any sort of impactful borrowers’ willingness to choose Lending Club versus somebody else? And how that might be filtering through to your guidance parameters? And also wondering, in relation to the population reduction, especially in lower credit tranches, were these eliminated or reduced tranches more easily or more difficult? Were they more difficult to acquire? And looking longer term, as you reestablish your relationships with the investors, are the eliminated tranches something you can think about reestablishing longer term or is this permanently off the table? Thanks.

[Scott Sanborn:]

Yeah, so on the question on borrowers your assessment is right in that, they are less likely to be exposed to recent events. And in fact, we have seen really no impact at all on borrower response rates. Our NPS has remained strong. We’ve even anecdotally gotten almost no questions on the topic. Our response rate remain very solid, so really no impact there. And as I mentioned, we were pleased that even with this kind of extraordinary series of events that we were able to deliver on our commitments and fund the approved applications. On the credit reductions, I think a way to think about this population is, it’s really around - I would view this as a bit of a normalization of credit. As this recovery gets longer, credit has become more available. And these individuals, in particular have shown a propensity to be building debt kind of coming into the loan and then continuing to accumulate debt after the Lending Club loan as oppose to leveraging the loan to kind of pay-off their debt. So is it permanent? I think this credit as a whole is pretty organic, and it’s something that is living and breathing. And I think these changes reflect the current environment, so I don’t think it's permanent. Also, there are things that we can do to manage this population differently through things like Direct Pay, which we launched earlier this year and essentially as part of the application process pays down existing debt. So I think if you couple that maybe with some monitoring tools, that would be the kind of thing that over time we could add. But given our more modest near-term volume ambitions and our desire to really boost the attractiveness of the asset, this was the right decision for now. And I think that’s evidenced by the investor demand that we’re seeing.

[Stephen Ju:]

Thank you.

[Operator:]

The next question comes from Michael Tarkan of Compass Point.

[Michael Tarkan:]

Thanks for taking my question. Scott, you mentioned looking at securing committed capital and some costs associated with that. Can you just kind of walk us through a little bit of the magnitude that you’re thinking about there in terms of how big that capital could be? And then what forms of cost those could take, whether it’s waiving servicing fees or issuing some sort of warrants or equity? Any color there would be helpful.

[Scott Sanborn:]

Yeah, I mean, I - the way we’re thinking about it. First and foremost, it needs to make a rational business sense. So I know and I’m sure you’ve seen it Michael, there has been a lot of speculation in the press, I would say that it’s a broad statement. Our asset stands on its own, and is something that is delivering attractive returns in and of itself. So that’s kind of the first and foremost principle. And exchange for committed capital, we certainly do recognize that there is a cost associated with that on behalf of the investor and I think on our side we would view it as needing to kind of fit within the business model and make economic sense for us. It would not be something we would necessarily look to obtain kind of across the entire platform. But I think a minority of our funding that when you have this together with the retail funding we have a very solid base at which to operate from kind of regardless of macroeconomic conditions.

[Michael Tarkan:]

Okay. And then on the retail side, can you just give us an update us to where thing stand with LC advisers? I know there were some heavy redemption requests by the end of June, I'm just wondering if that has abated at all?

[Scott Sanborn:]

So similar to what I talked about across a lot of our categories, I think the way NLCA investor signals the desired to plause is a redemption and indeed we saw that we have been quite busy taking a number of steps to improve our management communication governance over LCA funds. We believe in the value that LCA provides. It’s low cost access to this asset class in a kind of passive index format. So we are confident that over time we will be able to grow that particular source of funding again. But we do have some work to do on our side to get us there.

[Michael Tarkan:]

Okay. And then last one for me, I know one of your private competitor got a letter from the regulators in Colorado regarding lending under the Colorado law, just did you guys receive a similar letter and if so is it any impact from that?

[Scott Sanborn:]

No, we have not received a similar letter.

[Michael Tarkan:]

Okay, thank you.

[Operator:]

This concludes our question-and-answer session. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.