This Fintech stock thrives when interest rates rise

Consumer lending fintechs overly dependent on capital markets have been hammered this year amid rapidly rising interest rates. Investors such as asset managers who typically buy consumer loans have seen a higher cost of capital to fund these loan purchases and have also become more concerned about credit quality, with many fearing the US economy is headed for a deep recession.

But the digital marketplace bank LendingClub (LC -1.58%), which combines a leading online personal lender with a bank charter, seems to be navigating the environment well. Let’s take a look.

A record quarter

Founded in 2006 and making its public debut in 2014, LendingClub has been through many different economic cycles and has seen no shortage of ups and downs.

This experience is likely what led the company, which is very good at using technology and machine learning to create unsecured personal loans, to acquire Radius Bank in 2021. The bank charter allows LendingClub to create loans and use cheap deposits to fund a part of them. . It also lays down better frameworks for putting part of the loans on the company’s balance sheet. Loans that LendingClub puts on its balance sheet and collects recurring monthly interest income on are three times more valuable over their lifetime than selling them to investors for a one-time fee.

Image source: Getty Images.

As interest rates quickly rose in Q2 and disrupted capital markets, some fintech companies like Upstart (UPDATE 6.27%) had to cut its estimates for the second quarter and now expects to report lower revenue and a bigger loss for the period. That’s because they didn’t have enough investors to fund and buy their loans.

But LendingClub didn’t have to worry too much about this because it has deposits to fund a good portion of its originations and put about a quarter of those originations on its balance sheet. LendingClub also serves a high-quality borrower who makes more than $100,000 per year and has an average FICO score of 720 to 730, making them more resilient in a recession.

As a result, LendingClub didn’t have to slow down at all in Q2. The company reported its strongest quarter in originations since the acquisition of Radius, with more than $3.8 billion in the period. This led to record revenues and adjusted profits of $330 million and $46.8 million, respectively.

Looking forward

While LendingClub’s bank charter allows it to navigate the rising rate environment much better than other fintech specialists, the company is not entirely immune.

Although LendingClub does not use the securitization market and sells far fewer of its loans to the likes of asset managers, some of the company’s investors will still need time to adjust to the new interest rates after two consecutive 0.75 percentage point rate hikes. will require a higher return on loans, which may temporarily stop some of the financing from this group in the months ahead.

The good news is that LendingClub will eventually be able to pass these costs on to the consumer because its primary personal lending use is credit card debt consolidation. So as credit card borrowers raise the interest they charge on card balances, LendingClub can raise interest rates on its personal loans while offering an attractive value proposition.

However, this will take some time and put pressure on the amount of loan volume LendingClub can transfer to investors in the current quarter. That’s why the company’s forecast for Q3 came in lower than what investors were probably hoping for given such a strong second quarter. The company expects $280 million to $300 million in revenue in Q3 and about $30 million to $40 million in profit, both of which are down from Q2.

Still, given the intensity of the rate hikes, this is a fairly gradual decline and LendingClub still maintained its full-year forecast, which at the midpoint is $1.2 billion in revenue and $155 million in profit.

I think this is a good result in terms of the environment. It is also precisely for this reason that LendingClub bought the bank, according to CFO Tom Casey in the Q2 results: “In today’s environment, we lean more towards the banking model, are conservative on credit and use our low cost deposit financing to keep more loans for investments and generate recurring revenue. As the economy improves, we will be ready to lean on our fintech advantage, dialing up the marketplace to scale and capture market share.”

Continues to prime the pump

Amid a very difficult backdrop, LendingClub just produced its strongest quarter ever and is lowering its Q3 forecast very modestly. The bank charter allows it to be more defensive in tough markets (like today’s) and then step on the gas during periods of growth.

Loan demand is also quite healthy, with more than $1 trillion in outstanding debt in the US right now, creating plenty of opportunities for LendingClub’s main use case. If balance sheet growth continues to trend as it has, the company could exit the year with more than $4 billion in unsecured personal loan balances, which would generate plenty of recurring monthly interest income by 2023.

The market appears to remain concerned about a recession and how credit quality will hold up, and that has taken a toll on the shares, which are down 43% year-to-date. But given the high-quality borrowers LendingClub serves and the fact that the company reserves for loan losses in a prudent manner, I’m optimistic that it can successfully navigate difficult economic conditions. I continue to think the stock is a good long-term buy.