Investors just aren’t going to learn when it comes to LendingClub.
To be clear, this stock matters for two reasons. First, it’s a classic example of a “story” stock gone horribly wrong and as is usually the case, some investors are going to believe the story until they finally just go down with the ship. Second, and more importantly, the actual “story” behind LendingClub’s model is a nightmarish combination of FinTech and “originate to sell” and it’s being pitched as the future of finance.
We’ve talked quite a bit about P2P or “marketplace” lenders (see here and here for the latest) but we’ll recap briefly. LendingClub’s shares plunged early last month following an internal investigation into falsified loans sold to Jefferies and after it was revealed that CEO Renaud Laplanche failed to tell the board about a stake he had in a fund LendingClub was considering investing in.
The news got worse and worse in the days and weeks that followed as Goldman, Jefferies, and a consortium of community banks halted purchases of LendingClub’s loans. The company also received a grand jury subpoena from the U.S. Department of Justice.
While the regulatory scrutiny certainly isn’t welcome news, the real worry for those who follow the space is the prospect that the company and its peers won’t be able to offload credit risk going forward. This model is predicated upon the idea of “originate to sell,” wherein lenders make loans and then immediately sell those loans to investors or to banks who then package them and sell them as securitized products. As we’ve discussed here before, it’s the exact same model employed by mortgage lenders in the lead up to the crisis and the same model that’s working its way through the subprime auto market as we speak.
The problem for LendingClub and some of their peers is that they depend heavily on this dynamic to support lending. That is, if they can’t sell the loans, it’s not clear how long the model will ultimately be viable.
The stress in the sector was evident earlier this year when SoFi (another marketplace lender) started a hedge fund to invest in its own loans. That seemed to indicate that demand for paper backed by P2P loans may be waning. As it turns out, SoFi was able to tap the market this week. Here are the details from Bloomberg (citing Kroll):
“SoFi’s first rated securitization of unsecured consumer loans, the $379.8m SCLP 2016-1, has a top rating of Single-A, 25% CE, and is backed by collateral with a larger percentage of longer-term loans vs its marketplace lending peers, Kroll writes in a presale report.
“Transaction has ~56.3% of the underlying loans that have 84- month loan term, and WA loan term is ~70 mos. Peers in the prime loan space generally have WA loan term between 44 to 48 mos. However, SoFi generally makes longer loans to more credit-worthy obligors vs its peers, and the longer term allows for manageable payment sizes.”
Whatever you say. What sticks out there is that the loan terms are getting more extended which could suggest loans are being made to borrowers of lesser credit quality with smaller incomes. Or maybe not, but that seems like a reasonable supposition to make.
Getting back to LendingClub, shares rallied sharply around two weeks ago when reports indicated Citi might step in to assist the company in selling its loans. The stock closed at $4.81 that day. Here’s what we said: “you may want to fade this rip.”
Well sure enough, the shares fell all the way down to $4.13. Then, on Wednesday, it was time to panic buy LendingClub again. Shares closed some 6% higher:
Why? Let’s ask WSJ:
“LendingClub Corp. said that it purchased $18.7 million worth of loans in the second week of June, a surge from less than $1 million in the first week, according to a note from analyst Brad Berning at Craig-Hallum.”
Got that? They’re buying loans from themselves. Or, more simply, they’re carrying loans made through the platform on their own books. Here’s how the Journal describes the situation:
“That’s a mixed indicator for the troubled online lender.
“One the one hand, more loan buying means LendingClub is exposing itself to risk and increasing its capital needs, as it shifts from pure marketplace lender–in which all loans are immediately sold to funds and investors–into one that buys some loans itself.”
“On the other hand, it means LendingClub is leaving no stone unturned to ensure that it keeps funding loans it has offered to borrowers as it seeks to secure a new base of loan buyers.”
Let’s not kid ourselves. There’s nothing “mixed” about this “blessing.” It’s bad news, not good news. It means no one wants to buy their loans. It gets even more amusing when the aforementioned Brad Berning tried to spin it:
“We believe LendingClub does not intend to change itself into a [loan buyer] and likely intends to sell any loans it has purchased,” he wrote, in a note cited by the Journal.
Well yes, of course they “intend to sell the loans.” That’s the whole point. They “intended” to sell them in the first place and couldn’t. What Berning is saying there is akin to this: “Foot Locker has recently had to eat a bunch of excess inventory because no one wants their shoes, but we believe Foot Locker does not intend to change itself into a shoe hoarder and likely intends to sell any shoes it has purchased.”
Hopefully you can see the problem there. But just in case you need confirmation of why you should probably fade this latest dead cat bounce, we’ll leave you with a quote from the SEC filing in which LendingClub’s disclosed the DoJ subpoena:
“Historically, the Company's overall business model has not been premised on using its balance sheet and assuming credit risk for loans facilitated by our marketplace.”
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