This profitable Fintech stock is trading at a discount

This rising interest rate environment the US finds itself in has made it very difficult for fintech specialists in consumer finance to make money. Examples of this can be found at companies such as Upstart, SoFi technologiesand MoneyLionamong others.

But the difficult economic environment did not keep the digital marketplace bank LendingClub (LC 2.09%) from turning a profit every quarter since Q2 2021. Although the environment remains challenging, I expect the company to maintain a small level of profitability until market conditions become more favorable to the business model. With the stock now trading at a discount, I see this as a good time to get in. Here’s why.

Understand LendingClub’s business model

LendingClub’s main business is helping largely prime borrowers and above consolidate their credit card debt. This generates a high-yield, short-term loan for LendingClub, while saving borrowers a lot of money in interest payments on their remaining credit card balances.

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LendingClub became a bank after completing the acquisition of Radius Bank in 2021, and as a result it has access to deposits to fund loans and is well positioned to place loans on its balance sheet and collect periodic interest income. Over the term of a loan, loans on the balance sheet are three times more profitable than those sold to investors on LendingClub’s marketplace.

But the marketplace plays a critical role in the model because it allows LendingClub to originate more loans. When the marketplace operates at full capacity, the fees from the sale of loans can largely cover LendingClub’s expenses. When conditions are like this, the profit from loans kept on the balance sheet after setting aside capital to cover potential loan losses pretty much falls right on the bottom line.

Flexibility in a challenging environment

Unfortunately, the high interest rate environment increased the cost of capital for some parties who purchase LendingClub loans (such as asset managers). With a potential recession looming, investors are also nervous about credit quality. This has caused marketplace investors to demand higher returns on loans. LendingClub can reprice the interest rates on its loans like credit card loans, but that takes time, and since the Fed hasn’t slowed its aggressive rate hike campaign for over a year now, the company hasn’t been able to reprice loans quickly enough to keep up with the increased funding costs for investors.

But this is where having the bank’s flexibility has been huge. With capital markets frozen for most consumer fintech companies, struggling to find investors to buy their loans, LendingClub can simply raise more deposits and then keep more loans on the balance sheet. In fact, LendingClub increased deposits by 13% in the first quarter.

The company has to pay for these deposits in this type of environment, but with its main product – unsecured personal loans – still yielding more than 13%, it can handle the higher funding costs. LendingClub kept $1 billion of loans on its balance sheet in Q1, which is up from $700 million in the fourth quarter.

Putting loans on the balance sheet also puts the company on the hook for loan losses. But LendingClub has set aside reserves every quarter to cover future losses and has set aside enough to cover the equivalent of 6.4% of losses on the entire loan book. The annual estimated loss rate for lending in the 1st quarter came in at 3.8%. Losses will likely continue to mount, but LendingClub has a cushion.

LendingClub is still feeling the heat and margin compression due to higher funding costs and not being able to fully refinance their loans. Profits in the first quarter fell by 66% year-on-year, but the key is that the company is profitable in an unprecedented rising interest rate environment.

The share is traded at an attractive value

Investors are clearly concerned about credit quality and the path of interest rates. But when the Fed takes a break, so that LendingClub can fully reprice its loans, and there is more clarity in the economy, the market will recover. LendingClub CEO Scott Sanborn said that could happen very quickly.

The opportunity for LendingClub remains greater than ever, with revolving consumer debt now at an all-time high of $1.2 trillion and credit card interest rates now exceeding 20%.

LendingClub has no problem increasing demand from borrowers; it just needs to find places to put the loans because it can only grow its balance sheet so quickly due to regulatory capital restrictions. With shares trading at just 77% of tangible book value, investors can buy LendingClub shares at an attractive value ahead of any recovery.