Seven years after the financial meltdown that the big banks helped cause, banks are still sticking it to us by paying virtually nothing on our savings, while charging 16 percent on average on credit card debt — all the while peppering us with sneaky "gotcha" fees and high ATM charges.
That’s how a lot of consumers see the financial services business, and it makes them mad. After all, didn't we just bail out the banks?
So, naturally, consumers and investors alike perk up when they hear about a company using technology to steamroll banks by connecting borrowers with lenders — offering better loan rates in the process.
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"That's exactly what we do," Lending Club CEO Renaud Laplanche told me in an interview a year ago. Laplanche wasn't talking to the press in the blackout around his company’s initial public offering (IPO) today. But in the past year, the company he founded has only gotten better at stealing business from the banks that so many people love to hate.
"If there is a big sweet spot for disruption, it's financial services," says Tom Taulli, an IPO expert. "Everyone hates their bank and their credit card company, because they know they are getting ripped off."
This is one big reason why Lending Club revenue jumped 122 percent in the first nine months of the year to $143 million. Loans originated grew an impressive 117 percent to $3 billion. Looking ahead, there's room for much more growth at the world’s largest online lending marketplace, which helps explain why LendingClub stock spiked as much as 67 percent when it started trading Thursday after being priced at $15 a share, higher than $12 to $14 expected range.
Lending Club so far has only captured a small part of the U.S. loan business. Then there's the rest of the world. "They're at the right place at the right time," says Kathleen Smith, an analyst with Renaissance Capital, which specializes in IPO research and manages the Renaissance IPO exchange-traded fund (IPO).
Related: Peer-to-Peer Lending — Why Your Neighbor May Soon Be Your Bank
So, like other companies using online platforms to steamroll comfortable brick and mortar businesses — think LinkedIn (LNKD) in recruitment — Lending Club shares could do quite nicely post-IPO. Just be careful. Lending Club hasn't been tested in a weak economy. It's supporting growth by moving into riskier loans. And naturally, several competitors are circling. In short, just like bank stocks during the financial crisis, Lending Club might eventually swoon.
The Basics
Before we get to more detail on the possible pitfalls, let's take a closer look at what Lending Club does.
In some ways, this is a head-smackingly simple business. Lending Club's website connects private borrowers with lenders, making money in the process by collecting an average 4.4 percent fee on loans. Standard loans are for $1,000 to $35,000. A Utah-chartered partner bank called WebBank fronts the initial loan. It gets paid back as lenders fund loans on the website. So Lending Club carries no loans on its books. That's good, because if you buy the stock, you aren't exposed to default risk.
Why Lending Club Is Hot
Borrowers like Lending Club because they can get money at cheaper interest rates than their credit card offers, as little as 6 percent. On average, borrowers save 6.8 percentage points, or 32 percent of their interest costs, says the company, with no hidden fees or prepayment penalties.
Lending Club offers cheaper money for a simple reason. "An online market place that has no branch network can allocate capital more efficiently," says Laplanche. Indeed, he got the idea for the company after he noticed his own bank charged him 17 percent on his credit card debt, but paid him 0.5 percent on his savings. That seemed like a lot of fat to cut out, he says.
Related: Finally! Big Investors Declare War on Big Banks
Meanwhile, lenders like Lending Club because they get better yields. They earn from 4.7 percent to 7.5 percent. That's a good deal, at a time when money market funds and government bonds pay almost nothing.
This isn't just about your neighbor lending you money via Lending Club. Insurance companies, pension plans and hedge funds are in on the act, as lenders.
Big money coming into the game helps explains why Lending Club is has orchestrated $6 billion in loans since launching in 2007. Three factors suggest there’s much more loan growth ahead.
- First, there's a lot of debt left to refinance at lower rates. Consumers have $3.3 trillion in debt, according to the Fed, including $882 billion in the kind of revolving credit card debt this company likes to target. Lending Club thinks about $390 billion of this is easy pickings. Then there's the $300 billion in business loans under $1 million, according to the Federal Deposit Insurance Corporation. For context, keep in mind that Lending Club has helped create $3 billion in loans so far this year.
- Lending Club hasn't even begun to expand abroad. Many foreign banks are far less efficient than U.S. banks, so the potential here could be big, though foreign regulations could be tricky to navigate.
- Lending Club has a powerful brand. It has built a lot trust among lenders, based on a seven-year track record. "Setting these up is not hard," says Taulli. "The hard part is building the brand. Lending Club has a good reputation that's going to build on itself."
Three Big Risks
Despite all these advantages, be aware of three key risks with this stock, beyond the competition from companies like OnDeck, which goes public next week, Prosper Marketplace, and Funding Circle.
For one thing, unlike its loans, Lending Club stock is very expensive. It has a price to sales ratio of 9.2 compared to 7 for LinkedIn, another growth stock, on 2016 expected revenue for both. "Investors will have to see a big confirmation of the growth rate to see the valuation rise," says Smith. Put another way, the rich valuation means Lending Club shares could be a super-sensitive to any stumble. And the company does faces risks:
- To maintain growth, Lending Club has been moving into riskier loans. It's targeting small businesses more often, as well as people consolidating medical debt and student loans, and borrowers with riskier payback profiles. "To keep the growth up they are going down the credit scale, and a lot of times with financial institutions that does not end well," says Smith.
- The Fed will probably start raising interest rates in the middle of next year. "When rates increase, investors may go elsewhere for yield," says Taulli. "Or the cost of getting these loans might be higher, so people may want to go to the bank."
- Lending Club has never really been tested by an economic downturn. What happens when unemployment jumps and more Lending Club borrowers stiff lenders? Smith, at Renaissance Capital, wonders if lenders would get alienated after being burned by unexpected of write offs.
Given the valuation, even a slight slowdown in growth for any of these reasons could really hit this stock, says Taulli. "With one sign of a recession this could look like some of these energy stocks right now."
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.
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