loan club (NYSE:LC) continues to trade at pre-COVID levels where the company had a vastly inferior business model. The entire fintech banking sector is down on credit quality fears, but big banks just confirmed credit isn’t even normalizing to 2019 levels despite the Fed’s 225 basis point interest rate hikes. My investment thesis remains ultra bullish on digital banking not properly valued for the current business model with the possibility of expansion.
Limited credit risk
The main issues in an online lending market are twofold: credit risk and market investors. If credit risk were a real issue, LendingClub would no longer be in business to attract investors to the market. The biggest problem has always been retaining institutional investors during tough economic times.
Peer fintech Assets received (UPST) ran into this problem this year, with the company now planning to move to a new business plan that focuses on a committed capital concept. LendingClub has already solved this problem with its own balance sheet through the acquisition of a digital bank.
The company now has the deposits to continue investing throughout the cycle. The attractive business model of an online lending platform without credit risk simply does not work in practice. If the credit model doesn’t work, the business won’t last, whether or not the business avoided credit losses in the process. If the credit model works, the fintech or digital bank should simply invest capital in loans and avoid the inconvenience of outside investment partners who are not always willing to invest through cycles.
LendingClub is bottoming around $13 on credit risk fears and negative news from Upstart. Last quarter, LendingClub only repaid $14.7 million in loans while taking an initial credit provision of $70.6 million owed to CELC.
The digital bank lends prime personal loans to borrowers with an average FICO score of 721 and an income of $112,000. The company only faces over 30-day overdue payments of around 1.25%, while the average coupon on these loans is 13.1%.
At the time of the Q2’22 report, LendingClub saw no significant credit impact, but the company took a 6.9% provision charge on personal loans The good news from the industry last week is that losses credit, especially on credit cards, do not increase.
Bank of America (BAC) provided the following data points at the Barclays Global Financial Services conference suggesting that credit losses are not yet normalizing even to pre-COVID levels, let alone recession-like issues:
In August 2022, consumers spent 10% more than in August 2021… August increased by 10% compared to last August, transactions increased by 5.5 % to 6%.
So if you look at the core portfolio, it has shrunk and stayed there. And so if you look at the credit card charges, they’ve come down to half, I think, and stayed there. And it’s got to keep going – so we had 15, 17, 20 basis points to do anything in the last quarters and then we had 40 in 2019 you got something like 40 which was a historical low. So you sit there and say wait a second you’re not even normalized to an all-time low. So that’s the reality.
Our reserve methodology by which we establish the reserve assumes an unemployment rate of 5%. That’s three and a half months away and 5% through next year. This is the base case. Do we believe this will happen? No, but what is it – it’s a conservative construction.
Essentially, credit card charges are not even normalizing for pre-COVID levels, while the BoA has established credit provisions based on a much worse economic climate. The upside potential here is for banks to reduce provision balances.
Price for a recession
For months, LendingClub has been priced for a major recession. Fintech might not even face a major credit risk scenario even in a recession.
The stock trades at just 7.6x forward EPS targets and those estimates look conservative. Remember that LendingClub takes massive CECL fees up front, possibly delaying the company from beating EPS numbers.
Not to mention that the company continues to develop a full range of financial products after acquiring digital banking last year. Current estimates do not accurately reflect the fact that LendingClub goes beyond an online lending marketplace.
The key investor takeaway is that LendingClub remains rated for financial difficulty, but the company is unlikely to see an increase in loan repayments with consumers with strong balance sheets. The stock is too cheap to ignore at $13 and trades like a traditional bank, not a growing online financial market.