Michael Vi
LendingClub (NYSE:LC) announced on Friday that it agreed to acquire a $1.05 billion portfolio of personal lending loans from U.S. Bancorp. The loans originated through LC’s marketplace and are currently part of its servicing portfolio. The portfolio comprises highly rated borrowers with a weighted average FICO score of 729, which is in line with LC’s existing Held For Investment (“HFI”) carried on its balance sheet. LendingClub expects the acquisition of the loan portfolio to be completed by the end of 2022.
Initially, as the newswire hit, I was slightly concerned, thinking that this is another ominous sign of waning demand from investors for the asset class, in light of the rapidly rising interest rates and recessionary fears backdrop.
However, I quickly realized that this was an opportunistic trade that is very accretive for LC and potentially moves the dial materially in relation to its 2023 earnings profile.
The rationale for the acquisition
The seller, U.S. Bancorp, recently completed the acquisition of MUFG Union Bank’s core regional banking franchise and inherited these assets that it simply did not want. Apparently, these are not within its business model parameters and risk appetite as such it placed the portfolio up for sale in a competitive bidding process.
LC probably realized that acquiring the portfolio makes a lot of sense on a number of parameters:
- The loans have already seasoned as such the credit risk profile is relatively benign. In other words, seasoned loans tend to be associated with less risk and a more favorable reputation given that borrowers have clearly demonstrated their ability and willingness to repay the loans fully.
- The portfolio maturity has an effective duration lower than 1 year. As such, LC has elected to designate these loans as HFI under the fair market value option. This means that LC is not required to recognize expected lifetime losses under CECL. From an accounting (and earnings perspective) this means that the acquired portfolio will be EPS accretive (almost) from day 1 (absent the derecognition of $4 million of loan servicing asset).
- By acquiring the portfolio, LC is also supporting the liquidity of its marketplace. As I have noted in my prior article, given the macro settings many investors are currently on the sidelines. LC is leveraging the strength of its balance sheet to support the marketplace but in a very favorable risk/reward manner.
Should you be concerned about any red flags?
The short answer is no. This is all positive.
The portfolio was up for sale not because of investors’ panic or credit concerns – it was strictly due to U.S. Bancorp’s recently completed acquisition of MUFG Union Bank’s core regional banking franchise.
The accounting election as HFI under the fair value option does mean that no reserving is taking place under CECL. However, LC was completely transparent about this in the press release and no games were played. It does make sense for LC to take advantage of this accounting treatment given (1) the low inherent risk of the portfolio and (2) otherwise the transaction would have resulted in a significant day 1 reserving which would have reduced its capital available to originate additional assets in 2023. In other words, absent this accounting election, LC probably would have passed on this acquisition.
The financials
There is not enough information disclosed to fully and accurately compute the earnings impact but we can make some reasonable assumptions:
1) I expect a NIM of 11% in line with the current portfolio yield, this would translate to annualized NII of $115 million
2) I also conservatively assume around $20 million of loan losses given loans have fully seasoned and should present a materially lower risk profile
3) I assume an effective maturity of ~9 months (this is a sensible guess).
4) I am deducting $4m of servicing rights derecognition.
So putting this all together, this translates to approximately an incremental ~$67 million of pre-tax income. Considering LC’s market cap is currently just above $1 billion, this is clearly very material to the stock’s earnings profile and valuation.
Final thoughts
My bullish thesis on LC has always been premised on delivering significant operating leverage by increasing the size of the high ROE unsecured personal lending portfolio retained on its balance sheet.
LC has made amazing progress since the Radius bank acquisition and is now on target to enter 2023 with a portfolio size of ~$5 billion. This translates to an income stream of ~$550 from this portfolio alone and importantly, LC has already reserved for expected lifetime losses under CECL for the majority of this portfolio.
Currently, there are material headwinds affecting LC’s marketplace as certain investors are sitting on the sidelines at least until the Fed is done raising rates. Still, I expect LC to remain solidly profitable in 2023 even in a challenging environment for its business model.
The recent portfolio acquisition will clearly move the dial on the earnings trajectory in 2023. It also signals that LC is in a strong regulatory capital position to complete this deal. To me, it is a signal that LC will likely deliver a strong beat in Q4’2022.
