LendingClub (NYSE:LC) recently saw a sharp rally after reporting better than expected Q1 2024 results. Shares of the stock were up almost 20% with the stock moving from $7.50 to about $9 per share. I am of the opinion that this is just the beginning of an even sharper move higher for shares of LendingClub. I have covered this company well on this site with previous articles, and have been ahead of some large moves in the past. Tangible book value for LendingClub sits at just over $10.60 per share according to the most recent earnings presentation provided. Further, the company notes that the fair value of their loan portfolio is about $1.30 higher than the carrying value. Another way to think about this is that, assuming these loans perform as expected, the value of the company is actually closer to $11.90 per share on a book value basis.
LendingClub should not be trading for less than book value. Yes, they are a fintech and unfortunately get looped in with the likes of Upstart (UPST), a company that has performed terribly. Upstart and LendingClub serve different buyers and have different business models. LendingClub serves a higher income, higher credit “prime” borrower, while Upstart has historically served a buyer lower on the credit spectrum. LendingClub is also a bank, meaning they have their own capital to deploy, along with other innovative ways to allow asset managers and others to deploy capital against their personal loan product.
At the end of the day, LendingClub has been held back by higher interest rates, and a conservative approach to ensure that in both an uncertain rate environment and potentially uncertain economic environment the company can perform. Notably, the company has succeeded in navigating this difficult interest rate environment, as seen in this quote from the CEO on the most recent earnings call:
Importantly, we delivered net income of $12 million, marking 12 straight quarters of GAAP profitability since we became a bank, a notable feat given the turbulent macro environment over the last two years.”
The opportunity ahead of the company is massive. Credit card debt is at a record number of over $1.1 Trillion in the U.S.
As part of the Q1 2024 results, LendingClub issued guidance for $1.6 to $1.8B of originations for the upcoming quarter. Remember, this is a conservative company, and that generally applies for their guidance as well. Further, this guidance was given at a time that the 2-Year Treasury yield had moved up significantly in a short period of time. The 2-Year Treasury was as low as almost 4% at a point during Q1 2024 and had moved up to almost 5% by the time that LendingClub reported earnings in late April. The 2-Year rate is very important as LendingClub makes short duration loans, with an average life span of about 2-years (accounting for pre-payments and defaults). From an investment standpoint, anyone considering buying a personal loan is generally weighing the return on that investment against the risk-free rate of return from a 2-Year Treasury yield. The fact that LendingClub gave upbeat guidance for originations higher than Q1 2024, even as yields had moved markedly higher, speaks to both investor demand for this product and growing confidence that yields on the short-end of the curve had likely peaked. In fact, the 2-Year Treasury yield has already fallen by about 20-basis points as of May 9 which only increases my bullishness.
In the last 10-days, we have seen countless companies say the consumer is pressured and spending less. Look no further than Disney (DIS) and Starbucks (SBUX) and their most recent earnings reports. The consumer is cracking and in turn short-term yields should be falling. My opinion, is that the consumer is cracking even worse than the recent earnings reports show, and that the economy is going to slow rapidly in short-order.
Further, when the consumer cracks just one or two rate cuts are not going to re-start the economy. From a catalyst standpoint, I believe either the May or June CPI report (May report is next week) could provide the catalyst that sends rates plummeting as confidence again grows that the Fed will cut rates aggressively to stave off a recession.
LendingClub will be a massive beneficiary of rate cuts. Consider the following:
- LendingClub has over $7B of deposits that they are paying interest on to consumers. The average rate paid by the company in Q1 2024 was 4.75%. In a rate cut environment, LendingClub will see a significant tailwind as the company lowers the rate it is paying on deposits. Consider an environment where the Fed cuts rates by 150bps by the end of 2025 to try to re-start or stabilize a slowing economy. LendingClub can continue to be a leader with very competitive rates, and assume the company only cuts rates by 100bps even though the Fed cuts deeper. This 1% drop on the interest being paid on deposits would provide $70M in incremental Pre-Tax annually to the company. The loans the company holds on its balance sheet are obviously at a fixed rate, so a falling cost of funding those loans, becomes an immediate and significant tailwind.
- LendingClub recognizes revenue in two ways. The first way is from holding loans on their balance sheet, and net of interest being paid out for deposits (note above), collects net-interest income. The more important variable for LendingClub, which I expect to be a massive catalyst soon, is the company’s non-interest revenue. This line item effectively represents revenue from originating loans for others, or those loans the company originates with the expectation to sell to others after a short seasoning period. LendingClub generated just over $50M in non-interest revenue during Q1 2024 on $1.6B in originations. If you look back to Q1 2022, when interest rates were stable, LendingClub originated just over $3B worth of loans and generated almost $190M in non-interest revenue. Consider that for a minute, in an environment where rates are falling, LendingClub has the opportunity to originate significantly more loans and realize a better value on those loans it sells. We are talking about a $140M benefit, on a quarterly basis, when you consider the magnitude of what this market used to be if LendingClub returns to the same origination level prior to the rate hiking cycle. This could be a $560M annualized benefit to the company. Further, while there would be some variable costs associated with higher originations, I think it is conservative and reasonable to assume that at least 50% of that incremental revenue would turn into Pre-Tax income. That would mean the opportunity is almost $280M of Pre-Tax from higher originations at better pricing.
LendingClub has 12 consecutive quarters of GAAP profitability in a rate hiking cycle that is unlike one we have seen in decades. The company’s balance sheet is in fantastic shape. Between lower deposit rates, and originations moving back to historical levels, there is the potential for LendingClub to begin looking like a company that could have Pre-Tax income of $350M+ per year.
This is a company that currently sports a $1B market cap. If you don’t think there will be a massive re-rating higher in the price of the stock when the market truly believes rate cuts are coming, then I believe you are missing a fantastic opportunity.
If you believe credit losses will be an issue, then take a look at this chart from the company’s latest investor presentation:
Loss Rate (Lending Club Investor Relations Site)
LendingClub has seen significantly better credit performance as compared to the company’s peers in the personal loan space. In an environment where investors grow more concerned about potential job losses or other items that could impact credit performance, you can bet those investors will look to the company that has shown the best credit performance and the one lending to the most creditworthy borrowers.
The Final Take-Away
I think the catalyst could be as soon as the May CPI report next week, and I am not the only one who thinks CPI could surprise to the downside. Maybe it takes until June, but, we know that the Rent component of the CPI index is a massive lagging indicator. Just do a quick Google search for falling rents, and you will see that they have generally been falling for a year. Yet, this component of the CPI is not yet reflecting the fall in rents because of the way it is measured on a lagging basis. It would not surprise me at all for people to wake up in the next 45-days and believe that inflation is basically back to 2% when the rent component of the CPI begins to fall.
If you follow the Fed at all, you get the sense that they want to cut, and they want to cut bad. They need a reason to cut. CPI falling, after a softer May jobs report, and then the first spike in unemployment claims that happened this week would give the Fed the ammo they need to begin cutting. The market is a forward-looking mechanism. Rate cuts are a matter of when and not if, in my opinion, and when it becomes obvious that rates will have to fall hard it will be too late to buy LendingClub at the discount to fair value that you can get the shares for today.
This company is set to be a winner in a slowing economy, re-financing the record amount of credit card debt outstanding, and helping consumers with lower rates on that debt.
I will not be shocked at all to see LendingClub trading at $15 per share by this summer and moving over $20 per share when it becomes clear that rates need to fall hard but that the Fed is aggressively doing that to ensure a full-blown recession is averted.
