While Lending Club may have a strong balance sheet now with little or no debt, I don't think there are any covenants protecting retail investors from Lending Club incurring debt in the future to do stock buybacks, or making acquisitions that may or may not succeed.
A valid concern.
Here's how I think about it. Suppose that in some future year, LC takes on debt by issuing bonds, and then in some future year after that they go bankrupt. Suppose the bankruptcy judge gave us investors no special status, so our "notes" are ranked equally with those "bonds". Lets think about how bad that might be.
First, how we (note holders) come out depends on what the balance sheet looks like at that time. What would the balance sheet look like? Today the balance sheet is dominated by 4.5B of active loans on one side (assets), and 4.5B of notes (liabilities) to us investors. I'm going to ignore stockholder's equity, because we'll assume that the stockholders are wiped out in the bankruptcy. Today there's also 600M in cash on the balance sheet, but we'll assume they've burned thru all of that before declaring bankruptcy.
Next year, lets say end of 2016, the active loans will be something like $6B, matched by same $ of notes to investors. The year after that, say 2017, it may be $9B on each side. Suppose they then issue some very large amount of bonds. A $1B bond offering would be considered large. Lets go with that. Now it would take them awhile to eat thru the $1B of cash from that bond sale, so lets give them a year before they go bankrupt. So now we're at the end of 2018, at which time the balance sheet will probably show $14B of active loans, matched precisely by $14B of notes to us investors, and of course that $1B of bonds.
Suppose they go bankrupt at this point. Ignore the value of their furniture and whatnot, because it is small. Suppose that the brand has been so tarnished that no one will buy the brand or existing business out of bankruptcy. Suppose that by this time P2P lending is so tarnished by scandals and bankruptcies that no one even wants to buy the customer relationships. I'm trying to be worst case pessimistic here. The business just stops. (A rare situation, but it has happened.) There will be some employee related costs, and some legal fees. Suppose those add up to $100M.
Now lets see what assets and liabilities we are left with. We'll assume that the judge gives us no special treatment, and just shaves everybody equally.
I see $14B of assets, and $15.1B of liabilities. The assets cover 92.7% of the liabilities, and we all take a
7.3% haircut.
I don't see that as the end of the world.
Ok, maybe this isn't worst case yet. Maybe in addition to those bonds, suppose they took on bank loans in the amount of $1B.
Then we'd have $14B of assets and $16.1B of liabilities. The assets would cover 87% of the liabilities, and we'd take a 13% haircut. I would complain a lot, but still not end of the world.
I took a much much much bigger loss in my stock investments in 2002 and 2008. I took a bigger loss in my oil stocks in 2015.
When you invest in stocks, and consider the chance that a company you invest in might go bankrupt, you have to think of it as some probability that you will lose 100% of your investment. When you invest in bonds, it is seldom that bad, and in this case in particular,
the fact that the balance sheet is ballasted by this huge pile of consumer loans really improves the situation.
To be complete, I want to admit that there is one kind of loss that I didn't count in this calculation. Sometimes in a bankruptcy it is revealed that some of the assets on the balance sheet aren't in good shape, and may be worth less than the number shown. I've left this possibility out because as an investor in LC notes, you already have made a judgement that the underlying loans are good. For this reason, the above calculation is just about what might happen if the company goes bankrupt while the loans they've made are good.
It is possible of course that consumer loans will go to crap at some point in the future, but you take that risk when you invest in notes thru LC already. This calculation is about the risk that you will lose money in an LC bankruptcy, which we presume you would not have lost if there had been a bankruptcy-remote-vehicle. To say it a different way, this is about the specific risk we take because we do not have a BRV.
Of course the most likely scenario is that they do not go bankrupt at all, but continue as an ongoing business. If they do run into trouble, the most likely scenario is a buyout (at a very low price) by another lender, or some other reorganization which does not haircut our notes at all.
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