There are two great businesses to be involved in: distribution and being a middleman. With the former, you don’t need to be concerned with manufacturing and quality control. All that matters is sales, footprint, and logistics. With the latter, you make money just by putting people together. LendingClub Corp (NYSE:LC) is such a poorly run business that, despite the surge in need for consumer credit, it still can’t make money as a middleman.
That’s the simple reason why LC stock is down 75% since its its 2014 initial public offering.
The raw numbers would make it seem like this would be a solid business, but there is so much money being spent that it offsets income. Despite having almost $2 billion in originations through its platform in quarter, LC is limited to about a 6% revenue margin, giving it about $125 million in revenue for the quarter.
At this point, LC has originated a staggering $26 billion in loans over the past 10 years and still isn’t making money. It lost $30 million in the quarter.
Even worse, the full-year guidance was for a loss between $67 million and $77 million.
How do you lose money as a middleman?
I can’t be certain, but from the look of how LendingClub operates its business, I think it is spending way too much money on the back end. That’s what’s affecting the bottom line. By that, I think LC analytics and underwriting is where the problem lies.
What Should LC Do?
The market for consumer lending continues to grow, after a period of deleveraging among consumers after the financial crisis. What’s happening is that wages for most American workers are tied to the CPI, giving people a 3% raise each year, give or take. The problem is that actual inflation is closer to 10%, so people lose substantial purchasing power from one year to the next. They make up the difference by taking out consumer loans.
So with all this growth, any underwriter has to be careful about getting greedy and relaxing underwriting standards. Still, why is LC trying to reinvent the wheel when so many existing analytics platforms already exist?
What LC management should do is outsource its analytics and underwriting to Enova International Inc (NASDAQ:ENVA), which has been a consumer non-prime lender for almost 20 years. They managed to make short-term online loans by adhering to state short-term lending caps, which were about half what most online payday lenders were charging. They did this through robust analytics. Enova even advertises that it offers this service.
LC should be able to operate literally in the manner that eBay Inc (NASDAQ:EBAY) has since inception: just offer a platform. Have consumers apply online and then send all the stuff to Enova to underwrite. Just run the darn platform. Leave everything else to everyone else. Then market the loan to banks to fund and take a cut.
Now, LendingClub seems to be angling for the car loan business, which is not a great idea. Non-prime car lending is a dicey business and it takes tremendous expertise to underwrite properly. There’s a lot of repossession in this business, and LC is setting itself up for trouble by taking this route. The default rate is on the rise.
It’s a short-term run at an apparently easy target, but once the defaults start to pile up, LendingClub is going to have a lot of angry lenders who will feel they were sold crappy loans.
In the meantime, it’s not like LC stock can go much lower. It is buttressed by almost $2 per share in cash and it continues to generate capital via securitizations.
The real issue is whether the stock actually has any chance of going up from here. Considering the rest of the market is on fire and LendingClub stock hasn’t gone anywhere, I’m skeptical.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he did not hold a position in any of the aforementioned securities.