Because consumer balance sheets are starting to topple from $986 billion of outstanding credit card debt, online lending platforms for refinancing credit card debt see growth ahead. But not right away.
An interesting thing about financial markets is that other interest rates don’t rise at the same time as the Fed funds rate does. So CFOs like Drew LaBenne of LendingClub, who joined the company in July 2022, spend a lot of time thinking about rates — last year especially. In 10 months, the U.S. central bank’s benchmark rate rose to a range of 4.5% to 4.75% from its January 2022 range of 0.25% to 0.50%.
As the fast-moving upcycle in interest rates swept the capital markets, it required some adjustments to both sides of LendingClub's balance sheet.
“One of the challenges we face right now is the Fed has moved so fast, and we reprice our loans on a lag to the Fed,” LaBenne told CFO as 2022 drew to a close.
Why? Credit card companies don’t raise their rates right away, and to attract people to refinance, personal loan providers offer lower rates. Once credit card companies raise their rates, consumer lenders can. Personal loans are fixed-rate, so existing loans don’t reprice at all.
The Funding Side
Monetary tightening resulted in LendingClub having to raise rates on its high-yield savings accounts. Deposits reprice quicker than loans. LendingClub's highest-rate product now pays about 4%. Unsecured consumer loans still yielded over 13% in the fourth quarter, however, and net interest income increased 63% year over year, to $135 million.
The other thing quickly rising rates have changed is where the consumer loans land. LendingClub’s “marketplace” channel sells loans to other banks and fund managers. The volume of those sales is down.
"The level of increases [in interest rates] is dynamic," said LaBenne. "It created some stress in particular for our loan buyers because the cost of wholesale funding moved up instantly when the Fed started raising rates as the long- and middle-end of the curved moved up." (The personal loan terms are three to five years, but on average, borrowers repay in a year and a half.)
As Scott C. Sanborn, LendingClub CEO, put it on the company’s fourth-quarter earnings call, per S&P Capital IQ, “The relative value we can provide is compressed until we can reprice our loans to reflect the dramatic increase in the cost of funds, especially for our nonbank investors.”
While selling loans is a “capital-light” way to grow, said Sanborn, “it is less resilient in the face of market shocks like we have today.”
So, where do more of LendingClub’s loans go, for now? On its own balance sheet. In 2021, LendingClub bought digital lender Radius Bank for $185 million. Yes, LendingClub, one of the original peer-to-peer lenders, is now part bank. As of the end of the fourth quarter, the company's total balance sheet had grown to $8 billion in assets and $6.4 billion in deposits, both more than doubling year-over-year.
LaBenne credits Sanborn with having the foresight to acquire a stable, lower-cost funding source, a fallback that some of LendingClub’s competitors don’t have.
The company used to hold only about one-quarter of the loans it originated from, but that amount will be between 30% and 40% in the first quarter of 2023. LendingClub makes three times as much on such held-for-investment loans, even after having to comply with current expected credit loss (CECL) accounting rules.
Moving more loans onto the balance sheet, however, required remixing the portfolio to higher quality loans so as to limit credit risk exposure. The borrower in the average held-for-investment loan has a FICO score of 729, according to LendingClub.
LendingClub started tightening credit in early 2022. While consumer’s bank accounts grew during the pandemic, spending and inflation “ate away at that buffer,” said LaBenne. “We knew that we would probably see more stress in near-prime [borrowers that fall between subprime and prime creditworthiness] and maybe certain pockets of prime as well.”
Not an Easy Business
The larger company has been affected, too. With revenue flat, net income down year-over-year last quarter, and loan originations falling, too, LendingClub cut 14% of its employees (about 225) in mid-January. It also exited the commercial real estate lending and equipment finance business inherited from Radius, because the returns weren’t attractive. It plans to build up the acquired Small Business Administration lending business.
The business sounds very easy ... It’s actually very data intensive and experience-driven. — Drew LaBenne, LendingClub
TransUnion predicts unsecured personal loan delinquency rates will increase from 4.10% to 4.30% in 2023. But LendingClub has modeled for a worsening credit environment.
In any economic cycle, consumer lending is not a business to take lightly, as Goldman Sachs found out with its Marcus direct-to-consumer business.
“The business sounds very easy,” LaBenne said of consumer loans. “It’s actually very data intensive and experience-driven.”
Lending Club has the experience, having been in the industry since 2006. But LaBenne would still like the Federal Reserve to slow down and catch its breath, he told the audience at the Credit Suisse Financial Services Forum on February 14, according to the S&P Capital IQ transcript.
“Even a pause by the Fed at this point would be extremely helpful, allow us to catch up with the lag we have from the rate increases that have already happened," he said.