Tuesday, December 23, 2014


Lending Club (NYSE:LC) - Standing on the tracks waiting for the train......a case study

I was just looking at this one last week .  It's another impending disaster along the lack-of-disclosure-blood-lines of BABA.  Lending Club (NYSE:LC): The IPO just launched 12/11/14 with a debut Market Cap of $9 Billion......or about 90x revenues.  They lost $23 million in the 9 months ended 9/30/14, probably a full load of IPO costs and exec comp.....all though I've not spent the time to figure that out.

The business model, in my "accountant speak", is to severely under-price small business & non-recourse consumer loans and compete head to head with credit cards using other people's money.  They match "individual investors" with "qualified borrowers" anonymously and have launched this "web-enabled-ecosystem" in the most favorable interest rate environment in history.  (btw - "ecosystem" is the new buzzword for "we don't actually do any of the the work or add any value")

Here's the disclosure on pg 4.....they are under-pricing the loans by 6.8% (compared to current cost) on loans that are currently carrying a 21% Interest Rate (6.8% / 32%).....and they are comfortable lending money to folks who apparently think it was a good idea to borrow money at 21% in the first place :  

Access to Affordable Credit. Our innovative marketplace model, online delivery and process automation enable us to offer borrowers interest rates that are generally lower on average than the rates charged by traditional banks on credit cards or installment loans. Based on responses from 21,051 borrowers in a survey of 103,439 randomly selected borrowers conducted by us during the nine months ended September 30, 2014, borrowers who received a loan to consolidate existing debt or pay off their credit card balance reported that the interest rate on the loan they received through our marketplace was, on average, 680 basis points lower than the rate on their outstanding debt or credit card balances, representing a 32% savings.  

On page 56 of the filing they disclose the cumulative charge off percentage of their loans to be 15%. (Even most of their 3 yr and 5 yr loans are less than a year old)  I don't see that they've reserved adequately/(at all) for loan losses and they've apparently originated nearly $3 billion in new loans in the 9 months ended  Sept. 30th 2014.  (Again, in the most favorable interest rate environment in history) 

In other words, Lending Club most likely has an unrealized/un-booked  liability of $450 million +/- (15% of $3.B) from loans in place but yet to go bad.  On the P&L page F-5 they seem to do some odd "loan loss netting" calculations but the amount of this reserve and the calculations is not discussed. My guess....they are badly under-reserved.  IMO - They are actually out of business and they don't even know it.

As a financial person, the most important discussions contained in bank and insurance company financial statement footnotes relate to loss reserve calculations.  Oddly, there are no disclosures re: how the reserves are calculated and no separate line items on the P&L and Balance Sheet enabling an investor to track these calculations and evaluate them for reasonableness.  The loss reserves and charge offs seem to be "netted" against other fees and revenue.
Lending Club runs substantially all of it's loans through "Web Bank" p 15 of the Prospectus.  WebBank is a small bank in Utah with 38 employees and $200 million of assets.  Lending Club has about $2.5 Billion in "loans" on the books right now.....again, most less than a year old.  It looks like Lending Club underwrites the loan, Webbank issues the loan and immediately sells the loan back to Lending Club for a fee to get around SEC rules as described below in a "cease & desist" settlement against Prosper Marketplace back in 2008 when they gave it a go. (see below)

Here's the WebBank disclosure under:  Significant risks.  They disclose nothing about the financial viability of WebBank in the prospectus.  

If we are unable to maintain a relationship with an issuing bank, our business will suffer. We rely on issuing banks to originate all loans and to comply with various federal, state and other laws. Our primary issuing bank is WebBank, a Utah-chartered industrial bank that handles a variety of consumer and commercial financing programs. Springstone Financial, LLC (Springstone), which we acquired in April 2014, relies on NBT Bank and Comenity Bank as issuing banks for its education and patient finance loans. 

Our agreements with WebBank are non-exclusive and do not prohibit WebBank from working with our competitors or from offering competing services. Our current agreements with WebBank have initial terms ending in November 2018, with the possibility of two, one-year renewal terms, subject to certain early termination provisions as set forth in the agreements. WebBank currently offers loan programs through another online marketplace. WebBank could decide that working with us is not in its interest, could make working with it cost prohibitive or could decide to enter into exclusive or more favorable relationships with our competitors. In addition, WebBank may not perform as expected under our agreements. We could in the future have disagreements or disputes with WebBank, which could negatively impact or threaten our relationship.  

WebBank is subject to oversight by the FDIC and the State of Utah and must comply with complex rules and regulations, licensing and examination requirements, including requirements to maintain a certain amount of regulatory capital relative to its outstanding loans. We are a service provider to WebBank, and as such, we are subject to audit by WebBank in accordance with FDIC guidance related to management of third-party vendors. We may also be subject to the examination and enforcement authority of the FDIC as a bank service company covered by the Bank Service Company Act. If WebBank were to suspend, limit or cease its operations or our relationship with WebBank were to otherwise terminate, we would need to implement a substantially similar arrangement with another issuing bank, obtain additional state licenses or curtail our operations. Although we currently have a non-exclusive arrangement with Cross River Bank, another issuing bank, to date Cross River Bank has not originated any loans through our platform. If we need to enter into alternative arrangements with a different issuing bank to replace our existing arrangements, we may not be able to negotiate a comparable alternative arrangement. Transitioning loan originations to a new issuing bank is untested and may result in ......

Here's the summary Balance Sheet info in the filing:  Basically, they were leveraged at 20:1 (debt/equity) prior to the IPO in the consumer credit business.  Another IPO done to "save" the business rather than grow the business.  What could possibly go wrong?
  As of September 30, 2014
  Actual  As Adjusted (1)
  (in thousands)
Consolidated Balance Sheet Data:
    
Cash and cash equivalents
  $82,674    $740,409  
Loans (2)
  2,533,671    2,533,671  
Total assets
  2,814,846    3,468,646  
Notes and certificates (2)
  2,551,640    2,551,640  
Total liabilities
  2,673,306    2,623,034  
Total stockholders' equity
  141,540    845,612  
(1)The as adjusted consolidated balance sheet data gives effect to (i) the conversion of all of our outstanding shares of convertible preferred stock into 249,351,011 shares of common stock, (ii) the sale and issuance of 50,300,000 shares of common stock by us in this offering at the initial public offering price of $15.00 per share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, (iii) the issuance of 806,282 shares of common stock upon the exercise of warrants after September 30, 2014, (iv) the issuance of 27,629 shares of common stock that we expect to issue upon the net exercise of a warrant, based upon the initial public offering price of $15.00 per share, and (v) repayment of the full $49.2 million of indebtedness outstanding under our term loan and the elimination of the related debt discount and unamortized debt issuance costs upon the completion of this offering.
(2)Loans represent unsecured obligations of borrowers originated through our marketplace. Notes and certificates are issued to investors and represent repayment obligations dependent upon receipt of borrower payments as to a corresponding loan. For more information regarding notes and certificates, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Overview." Period-end differences between the two line items are largely driven by timing of applying and distributing loan payments to investors.

Here's another "Risk Disclosure" acknowledging that there are "relatively few" investors providing funds....(aka money launderers & suckers) and the identity of these investors, of course, are is not disclosed or discussed:
A relatively small number of investors account for a large dollar amount of investment in loans funded through our marketplace.
A relatively small number of investors account for a large dollar amount of investment in loans funded through our marketplace. Although we believe there is substantial excess investor demand to replace any investors who may choose not to continue to invest through our marketplace, if we are unable to attract sufficient investor commitments or investors do not continue to participate in our marketplace at the current rates, we may be unable to increase our loan originations and our revenue may grow more slowly than expected or decline over the short term. In addition, if a large number of our existing investors ceased utilizing our marketplace over a short period of time, our business could be temporarily interrupted as new investors complete the administrative and diligence updating processes necessary to enable their investments.

Finally, in addition to the  dubious finances, losses - both stated and hidden and the high probability of under-reserved loan losses- LC has another problem to deal with: competition. The article cites some of the new competitors emerging in this rapidly growing industry.

http://www.forbes.com/sites/navathwal/2014/12/18/lendingclub-ondeck-ipos-billion-dollar-valuations-are-just-the-beginning-for-the-online-lending-market/

The case you can make for businesses like Alibaba and Amazon is that the "network effect" means that only a few companies will succeed in their respective industries.  Both buyers and sellers will gravitate towards the largest player where they'll have the most buyers to buy from or sellers to sell to.  But this isn't the case for on-line lending - people can go to multiple sites to look for the lowest rate, just like they would for a regular bank.  Which means that, even if they're successful, LC will always be operating with thin profit margins due to heavy competition.  Therefore, the business should be valued more like a regular bank at one or two times revenues, or maybe 5x revenues as a startup, but not the current 90x valuation it carries.

The only advantage that Lending Club might have over traditional bank lending is that their "loans" are already securitized (i.e. they are already loaning other people's money) so there's no need to package and sell the loans as CDO's, etc....there's no need to get some underwriter to slap an A+ rating on them and sell them to investors.....it's already done!  On the other hand we've seen this movie before and we all know how it ends

Because of all of the above, Lending Club investors, like so many investors today, are obliviously standing on the tracks, biding their time, hoping that this business model is the next big thing......but in reality, they are just waiting for the next economic train to run them over......all aboard!
Here's the entire filing & additional References:
In 2008, the SEC sued "Prosper Marketplace"  for essentially the same business model and the company was delisted......I wonder what's changed?...other than running the loans through an FDIC insured bank for a few seconds. 




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