In the fourth quarter of 2021, the digital market bank loan club (NYSE:LC) reported diluted earnings per share (EPS) of $0.27 on total revenue of more than $262 million, two numbers that beat analysts’ estimates. However, management’s forecast of expected 2022 creations and earnings disappointed analysts and investors, triggering a more than 30% sell-off in shares the day after the results.
As the LendingClub stock was the largest position in my portfolio, I wasn’t in a really good mood last week. But after taking a closer look at the earnings report, I decided I wasn’t ready to give up the title just yet. I believe it can still generate strong returns and significantly increase profits in the years to come. Here’s why.
Examination of the lower guide
LendingClub, which uses technology to streamline the unsecured personal lending space, completely transformed its business model in 2021 after acquiring branchless Radius Bank and its charter bank last year. The banking charter allowed LendingClub to collect and use deposits to fund a portion of its loans, issue loans internally rather than using a partner bank, gain regulatory clarity and to put in place a better framework for holding a portion of the loans issued on the balance sheet. These changes caught investors completely off guard, and at one point enthusiasm for the stock sent the price soaring to nearly $50 per share (it now trades below $18).
But management’s forecast of $130 million to $150 million in net profit this year implied a lower profit level than analysts had expected for this year. Additionally, the projected $13 billion mounts in 2022 implies approximately 5% growth from the run rate of mounts that LendingClub has created over the past two quarters. For those who value LendingClub as a growth story, below-expected revenue and modest creative growth isn’t exactly what you want. Nevertheless, forecasts imply that revenues will increase by 40% in 2022 and profits will increase by more than 630%. But given all the noise of earnings in 2020, that’s a tough comparison. Earnings in the first quarter of this year are expected to remain essentially flat compared to the fourth quarter of 2021.
Following the indications and fourth quarter results, investors seem less inclined to value LendingClub as a fintech and prefer to value it more as a bank, which comes with lower multiples. LendingClub also saw an increase in loans that are likely to go bad in the quarter – although there is no suggestion of anything over what management has been guiding – and the company also plans to increase technology and marketing investments. in 2022, which will also reduce profits. .
Where do things go from here for LendingClub?
Despite disappointing forecasts, LendingClub can still significantly increase its profits in the coming years. Its most attractive income stream comes from the portfolio of unsecured personal loans it holds on its balance sheet and earns monthly recurring income, otherwise known as net interest income, which is the money banks earn. on loans and securities after having covered the cost of financing them. assets. The bank usually keeps 20% of these on the balance sheet, although it will go as high as 25%. These held-to-complete loans are three times more profitable than the loans LendingClub sells to other banks and asset managers.
LendingClub’s business model is still focused on origination volume, but the company gets more for its money by retaining loans. For example, in the fourth quarter of 2019, before LendingClub had the banking charter and in the fourth quarter of 2021, the company made the same amount of loans at $3.1 billion. But thanks to the banking charter, LendingClub was able to reap nearly $74 million in additional revenue and $29 million in additional profit from that same origination volume. The company is still early in the process of building its unsecured personal loan portfolio. Given that LendingClub expects to make $13 billion in originations, keeping 20% would add an additional $2.6 billion in unsecured personal loan originations to the balance sheet. That would boost the pound by about 144% this year, but bear in mind that the actual growth will be less than $2.6 billion as loans will be prepaid and come to term. As the unsecured portfolio grows rapidly, it will also rapidly increase net interest income and increase profits.
There are also good reasons to believe that LendingClub may exceed forecasts this year. Management hasn’t missed its earnings or its own internal forecasts since buying Radius. While investors may be frustrated with the lack of growth in origination, assuming LendingClub does $13 billion in origination and the annual personal loan market is around $81 billion a year, that means that LendingClub still grabs around 16% of the personal loan origination market. It’s near or at the very top of the market, so if that market grows, I’m sure LendingClub will do more originations.
LendingClub CEO Scott Sanborn on the company’s recent earnings call noted that in the personal loan market, “the disproportionate growth over the past 12 months has really come from subprime and near-prime [borrowers]“LendingClub is participating in the prime space, with the average FICO score of its borrowers hovering around 700. So most of its target market is likely still in good financial shape and perhaps not going into debt like before.
Additionally, loan balances have started to climb in the credit card space. Total outstanding revolving debt in the United States ended November at nearly $1.04 trillion. An important use case for LendingClub’s unsecured personal loan product is to help people consolidate their credit card debt. The Federal Reserve is expected to raise its federal funds rate several times this year, to which many credit card interest rates are linked and with which they move. Seeing interest rates on their credit cards steadily increase should give consumers more incentive to consolidate their debt. With the average term of loans on LendingClub’s balance sheet at just over 16 months, the company can reposition its balance sheet to have higher-yielding assets on hand fairly quickly.
Valuing the company
It appears investors are hesitant to assess LendingClub as pure fintech, fearing that regulatory capital or the size of its addressable market will limit growth. Currently, the company is trading around 13 times its forecast earnings for 2022. Most large banks are trading in the 11-14 range, while smaller banks with excellent performance metrics may be trading higher. In the middle of the management range, LendingClub forecasts earnings of $140 million in 2022. The company’s equity within the parent company was $850 million at the end of 2021, an increase of approximately $46 million from the prior quarter. This would equate to a return on equity of 16.5%, which is very high in the banking industry.
LendingClub also grew its equity by over 17% in 2021, which should continue to fuel growth and remain in compliance with regulatory capital ratios. This stock growth is hurting returns, but hopefully that will slow down at some point. If the company can beat forecasts this year and receive an earnings multiple of around 15 to 20, there is certainly strong upside potential now and in the future. I think LendingClub investors will probably have to be a bit more patient than I initially expected, but I still think a long-term winner exists here and I plan to hold the stock.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.