Lending Club: Bringing Loans to the Masses
Lending Club has disrupted the lending industry through its business and operating strategy
Lending Club (NYSE:LC) is an online lending marketplace based in San Francisco, CA. Lending Club provides consumers with access to small and medium sized loans (typically $10-15K borrowed per loan). Although the Company started as a peer-to-peer loan marketplace, Lending Club’s funding partners are primarily banking and financial service institutions, who fund and hold the loans that Lending Club generates through its platform. Lending Club currently has a market capitalization of $4.9B and generated $360M in trailing 12 month revenue.
The business of lending is made up of three particular activities: originating, underwriting and servicing a loan. Originating is the process through which a lender generates demand for a loan, including direct mail marketing, referral programs, advertising, etc. Underwriting refers to the pricing of a loan based on the risk level of the borrower, as assessed through credit scores, demographic information and other information sources. Servicing a loan involves providing ongoing customer support to borrowers, reporting for funding partners, collections, etc.
As an intermediary between its borrower base of consumers and its institutional funding partners, Lending Club must add value in one or more of the three areas of originating, underwriting and servicing in order to be a sustainable business. Several aspects of the Company’s operating model help it add value in these three areas.
Originating
Lending Club, relative to its primary competition (i.e., banks and credit unions), focuses mostly on online marketing channels (video, retargeting, email, etc.) that are untapped by its incumbent competitors. Lending also obtains critical cost and conversion data by choosing this scope and can mix towards more cost-effective channels over time. Its partner strategy has also been informed by a desire to add value in originating a loan. The company partners with several online community banks in order to receive warm leads to potential borrowers, reducing borrower acquisition costs. Furthermore, the Company offers potential borrowers a seamless, mobile and Web-enabled interface that significantly improves the borrowing experience. On the other hand, traditional lenders’ loan application processes are renowned to be long, confusing and cumbersome. In fact, a study conducted by management showed Lending Club had a net promoter score (NPS) of 70+ vs. national banks, who have an NPS of 3.
Underwriting
Lending Club must maintain high underwriting standards and loan performance in order to retain the funding sources on its platform. The Company’s hiring strategy is informed by this goal, as it recently recruited Capital One’s former Chief Credit Officer Sandeep Bhandari to its executive team. Bhandari is tasked with developing Lending Club’s proprietary risk and pricing model. As part of this effort to improve underwriting, Lending Club is working on introducing additional, non-traditional criteria (social media data, e-commerce data, etc.) into its risk
scoring algorithm to achieve at a differential view on a potential borrower relative to a bank. In addition, Lending Club’s borrowers also “self-serve” when obtaining a loan, completing many of the steps autonomously without direct help from any Lending Club employee. This allows the Company to cut costs in the underwriting process, which is helpful especially in light of the fact that Lending Club is funding smaller loans on average relative to a bank and therefore earns less money per loan.
Servicing
Lending Club services its loans through technology-enabled processes that also improve user experience while limiting costs. For example, the Company has been able to develop algorithms that identify accounts who require a particular type of customer service. These algorithms make customer service labor incredibly efficient, and allows Lending Club to hire fewer people for a given borrower base. Additionally, the Company has a wide variety of IT tools that assist with the management of delinquent and defaulted accounts, improving collections rates. The Company also reports delinquent accounts to the credit agencies on a monthly basis, creating significant disincentives to missing mandatory loan or interest payments.
Lending Club is an example of a highly effective business that has formulated its operating strategy based on its business model. The company has great prospects going forward as it has put in place a number of operating initiatives to help it be a better originator, underwriter and servicer of small to medium consumer loans.
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Sources: Lending Club SEC filings and publicly available news articles.
Really great post that clearly links the company’s business and operating models together. Lending Club is such an interesting company!
My first question is around their underwriting processes. As you mentioned, in order to make their processes more consumer-friendly and attract more people, the Lending Club is trying to make the data collection process less cumbersome / shorter. It also seems that they are making up for the missing data by including other types of risk assessments – such as social media data. Do you think these external data sources can adequately compensate for the less rigorous data collection from the customer? Cutting costs in the underwriting processes sounds a bit risky to me.
In addition, will they have to charge higher fees? Presumably they will (at least initially) be attracting riskier customers who cannot get loans (or get loans with unattractive conditions) elsewhere due to the more rigorous processes.
Overall, I really enjoyed reading this post!
Although, I am not as financial savvy as the author ;), below are my two cents.
I think this is a great model that really brings value to the customer by cutting out waste and inefficiency in the process. However, I do not think the customers attracted to Lending Club are the customers its competitors, banks and credit unions, want. It seems like this club would attract customers who could not get a loan otherwise due to risk of the company or expected future cash flows as we learned in FIN 1 🙂
My hunch, is that a company with good credit worthiness and a solid business plan would get funding directly through well know institutions vs paying extra to a fairly new online company (just had IPO) with no long-term reputation. I would be interested to see the bad debt and default rates of the Lending Club vs banks and credit unions.
I think this is a good model to capture small/mid sized companies that would be otherwise be rejected but I do not think it is a game changer for the competition. If the model is based off of more risky businesses, I would be a little worried about the long-term sustainability of Lending Club as banks and credit unions are diversified with deposits and other products.
Akash, this is a great overview of how Lending Club creates value in unsecured consumer debt. I think an important part of the operating model that ties with this is that Lending Club uses its IT tools to identify types of accounts that might appeal to different types of investors, based upon their risk appetites and the lender’s profiles (reducing the search and information costs for the lenders). I’m interested in how Lending Club’s model would weather an economic downturn because I’m not sure what the differences are in the risk profiles of these borrowers versus borrowers that would go to a bank for the larger loan and longer lending process that you discussed.