Morgan Stanley analysts have posted their regular LendingClub public company analysis.
A few items stand out :
“LC expects returns from its investors to decline in the coming cycle turn”
When the cycle turns it is of course expected for the LC returns earned by its investors to also decline. The report notes that Small and Medium Business loans have historically been a good lead indicator of such return deterioration and LC expects to use their SMB lending data to try to make early adjustments for their consumer underwriting ahead of a downturn.
It does have to be noted that if LC adjusts consumer underwriting to become more stringent ahead of its competition then most likely it will lose its customers who typically compare a few prices from a few portals. Being a public company LC will hurt much more if its fundamental consumer loan numbers then deteriorate and its stock will be hit heavily. Therefore it is unlikely LC will toughen its underwriting enough to make a difference even if it could.
“Madden risk minimal”
The report and LC claim the Madden risk to be minimal. However we have seen that all securitizations in the consumer loan space recently have avoided any loans in 2nd circuit region where the Madden case was affected. Attorneys in general have proposed 2 or 3 solutions for a Madden proofing plan which for example consists in having a bank retain on its balance sheet 1% of each loan. We believe the Madden risk to be real and not minimal and while solutions exist they are hard to put in place as the bank-1% solution will make securitization for example much more complicated.
LC is expected to launch a new product line next year. We can only speculate but we would assume it will be student loans or mortgage offering. Due to its size LC can only launch categories that have a chance of making a real impact to its numbers. And a fail launch will cost them much more then not launching anything. We strongly believe that LC would be better off acquiring small P2P companies and marketplace lenders as it will be a much better risk to reward return.
“LC expects rising interest rates to have minimal impact on consumer demand”
It is not surprising that consumer demand will not vary a lot if the average interest rate will go up by a few points. The main people at risk in case of higher interest rates are the people who bought 5 year notes and are stuck with a note at 5% interest while the inflation could potentially go to 6% or higher.”
Report claims “Fewer new entrants in the market and reduction in valuation”
While the reduction of the Snapchat valuation recently has attracted headlines we have not seen any down-rounds or valuations reductions in our p2p and marketplace space. Furthermore many service providers and quite a few people now have experience, templates and information on how to setup p2p and marketplace lending companies. We therefore strongly believe that competition is increasing. LC has many strengths but counting on the competition not learning or doing a good job is not a good approach. Availability of capital in this space which is highly capital intensive and dependent is probably the best barrier for competitors.
“Reduction of Cost of Customer acquisitions for LC”
The report also suggest that the LC brand and notoriety is growing which continues to significantly reduce LC’s Cost of Customer Acquisition (CAC). LC has claimed in the past a CAC of $200 per customer. However other people who have studied their reports have claimed that their CAC is more around $400 then $200. In all cases a reduction is great news for LC as it is probably one of the top 5 Key Performance Indicators in our industry together with revenue-per-loan, defaults and cost-of-capital.
The full report can be found here