Author Topic: LC interest rates updated 5/8/2018  (Read 1623 times)

Fred93

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LC interest rates updated 5/8/2018
« on: May 08, 2018, 09:49:20 PM »
LC adjusted interest rates today, but the adjustments are shockingly TINY and therefore meaningless.  Can you believe they increased some rates by 0.12% ?   ZERO POINT ONE TWO.  You can just barely see this on the chart if you look really hard. 

The 8k filed with the SEC today describes it this way "Effective May 8, 2018, interest rates on the LendingClub Corporation ("LendingClub") platform have been updated. The changes are an increase of 0.12% for loan grades A2-A5, 0.15% for loan grades B1-B5, and 0.45% for loan grades C1-C5."

My updated chart...


The red dots on the A1 line are just there to highlight the dates at which LC made interest rate changes in any grade.

jd

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Re: LC interest rates updated 5/8/2018
« Reply #1 on: May 09, 2018, 11:49:10 AM »
Morning Fred,

I always appreciate your thought out view points. I had a few questions if you are so inclined to answer:

1-What would you have expected them to raise the rates to?

2-Are the increases good or bad for: (A) the stock price (B) the investor who funds the loans (C) the borrower?

Thanks


Fred93

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Re: LC interest rates updated 5/8/2018
« Reply #2 on: May 09, 2018, 03:06:22 PM »
1-What would you have expected them to raise the rates to?
2-Are the increases good or bad for: (A) the stock price (B) the investor who funds the loans (C) the borrower?

Lower is better for borrowers.  Higher is better for investors.  What is good for the stock price is more complex, and in the end is not my problem.

Let me address investors' point-of-view first.  I'm an investor.

LC has held the A1 rate at 5.31% since early 2014.  Meanwhile, some things have changed.  Interest rates on competing fixed income investments have changed.  Short term risk free rates (such as 3 month T bills) have gone up about 1.75% .  A risky fixed income security should trade at the risk free rate + some spread.  If the risk free rate goes up, then all fixed income investments should move up.  This picture shows you how dramatically short term risk-free rates have gone up...


I made this graph with the same time scale as the chart of LC.  The last data point on the red curve is 4/23/18.  Last data point on the blue curve is 4/1/18.

The return that an investor gets from an LC loan is reduced by the chargeoff rate of course (whereas the risk free asset has no chargeoffs).  LC's latest suggestion is that A loans are expected to have an annualized chargeoff rate of 1.85%.  Now I gotta tell you that in recent years, LC has underestimated chargeoff rates, so I don't necessarily endorse that number, but if it turns out to be right, then the investor will expect to receive about 5.31%-1.85%=3.46% per year.  (one could do a fancier calculation, but I'm keeping this simple.)

Back when the T-bill rate was near 0, that would have been about a 3.46% spread over the risk free rate.  Now that the risk free rate has moved up about 1.75%, the spread is something like 1.71% .   The spread has been CUT IN HALF.  Hmm.  Not good for investors.  In particular, this makes LC loans less attractive relative to other investments.

Keep in mind that the alternatives to investing in LC notes include things other than the risk-free T-bill.  For example, right now short-term muni bonds in California are especially attractive.  [We want to be careful to compare only short-term securities to LC notes, because LC notes are short term.]  Today 3 to 12 month AA rated CA muni bonds are trading at about 1.5% YTM.  I'm in a 54.1% combined tax bracket, so we divide that tax-free yield by (1-0.541) to get a taxable equivalent yield, and it comes out 3.26% !

So short term CA AA munis are trading at roughly the same expected return as LC "A1" notes right now.  Wow.

The rate environment has changed, and LC has not adapted.  To look reasonable to investors, LC needs to raise everything by at least 1% immediately.

Meanwhile, to make things even worse, chargeoff rates are increasing.  They've increased dramatically for LC loans at the high risk end of the spectrum, but they have been increasing some in every LC grade.  There has been no good explanation of this from LC, so we have no idea whether they even understand what is going on.  Pretty scary.  After all, this is happening in a good economy, with very low unemployment rates, etc.  The Federal Reserve data doesn't show such chargeoff rate increases for bank loans in general.  Its a bit of a mystery, and that increases our risk that we'll be further blindsighted.

At this point I'd like to show you some data on chargeoffs, but there is a dilemma.  If I wait until loans of a certain vintage are complete, so that I have the final and precise number, that data is available so late that it is useless for prediction.  To solve that problem, I'm going to show you chargeoff rates (fraction of total loan value charged off) at a certain point in the loans.  I've picked month 8.  Its early enough in the loan that I can present data thru 17Q2 vintage.  Don't try to figure out how to use the absolute number on the vertical scale for now.  Just look at the trend.  I'm going to show you how chargeoff rates thru month 8 have varied from vintage to vintage.  Think of it as an "early look" at how chargeoffs are running.  If chargeoffs for recent vintage loans are higher at month 8 than they were for earlier vintage loans at month 8, then it seems likely that this may predict higher chargeoffs overall after these loans are complete.  It ain't perfect, but its all we have to guide us to understand how recent loans are behaving.

In this chart, each curve represents all LC 36 months loans of one grade.   The horizontal axis is vintage (ie the date the loan started). 



Look at the range of dates from 14Q1 thru the right side of the chart, all those curves are moving up as the move to the right.  Anyone can see this.  Chargeoff rates are getting worse.  Yes, even our low risk grade A loans have are showing higher chargeoff rates in recent vintages.

So not only have competing interest rates moved up dramatically, but the quality of the LC product (ie the chargeoff rates on LC loans) has gotten worse.  LC has increased rates on some grades a little bit, and some not at all.  The result is not good enough to make me feel about LC loans the way I did in the past.  For that reason I'm reducing my allocation to LC notes. 

That's the investor's point of view.


Now you asked what I "expected" LC  to do, and you asked what is good for the stock price.  These are coupled.

I believe that LC management is thinking mostly about VOLUME.  They're thinking that to satisfy wall st, they have to make profit, and to make profit they have to get the volume of loans to grow.  There is a lot of competition in the lending business these days, so I believe they're thinking they have to keep rates as low as they can get by with, to keep their product competitive as possible with borrowers.

The problem with this is that if you let the quality of the product decline, perhaps investors will look elsewhere.  Right now LC is having success attracting bank money.  I'm not sure I understand exactly why that is so, but we see it happening.  As long as those bank investors keep pouring in money, LC probably sees no pressure to raise rates.  However, this cannot continue indefinitely. 

I don't claim to understand the banking business, so I don't claim to understand how long banks will pour money in as competing interest rates rise and LC loans interest rates do not rise.  I don't claim to understand when banks will react to the increasing chargeoff rates.  But if you believe that at some point banks will reduce their enthusiasm for investing in LC loans, that should inform your guesses about the long term growth rate of LC's business, which should drive your estimate of what the stock is worth.

Rob L

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Re: LC interest rates updated 5/8/2018
« Reply #3 on: May 10, 2018, 09:24:48 AM »
I don't claim to understand the banking business, so I don't claim to understand how long banks will pour money in as competing interest rates rise and LC loans interest rates do not rise.  I don't claim to understand when banks will react to the increasing chargeoff rates.  But if you believe that at some point banks will reduce their enthusiasm for investing in LC loans, that should inform your guesses about the long term growth rate of LC's business, which should drive your estimate of what the stock is worth.

Thanks for the nice post. I don't understand the relationships that banks have with LC either. I know they do or at least did buy individual whole loans. That was a long time ago. Then there's the structured deals and securitizations. Aren't these a part of the bank slice of the pie? Think I've read that LC can sweeten the pot for these deals, for example sharing originations fees with the purchaser, reducing servicing fees, certain guarantees, etc. Basically the purchaser of a structured basket of loans may be receiving a significantly higher ROI than an individual whole loan or note purchaser would have received for the same loans and/or notes. I dunno; just a thought.

bluto

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Re: LC interest rates updated 5/8/2018
« Reply #4 on: May 10, 2018, 10:56:52 AM »
Banks are likely interested because they can easily buy a geographically diverse portfolio of consumer debt that even at LC's current yields is above their average earning asset of 3.73%, and above the average consumer focused bank's average rate on earning assets of 4.02% (and those are gross yields, before financing costs and bad debt expenses).

https://www.fdic.gov/bank/analytical/qbp/2017dec/qbp.pdf

Leveraged up with ultra low rate deposits, and they can get a very nice Return on Equity from the A grade notes (the increase would add nearly a full point to bank RoE). 

Fred93

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Re: LC interest rates updated 5/8/2018
« Reply #5 on: May 10, 2018, 03:51:01 PM »
Banks are likely interested because they can easily buy a geographically diverse portfolio of consumer debt that even at LC's current yields is above their average earning asset of 3.73%, and above the average consumer focused bank's average rate on earning assets of 4.02% (and those are gross yields, before financing costs and bad debt expenses).

https://www.fdic.gov/bank/analytical/qbp/2017dec/qbp.pdf

Leveraged up with ultra low rate deposits, and they can get a very nice Return on Equity from the A grade notes (the increase would add nearly a full point to bank RoE).

Thank you for that link.  The #s in that publication are for 4Q2017.  The 30 day T-bill has moved up about 0.5% since then!  I don't mean to imply that banks should care about the T-bill rate directly, only that this shows that competing rates are moving up.  Banks may be sheltered for awhile, because depositors have forgotten that bank accounts used to earn money, but eventually must feel this pressure.

I think one part of the big picture is now that LC is selling significant fraction of its product to banks, that means you and I (ie direct investors in LC notes) are now competing with banks, when we weren't before, and banks seem to have lower expectations.  That has reduced the opportunity for us here somewhat.


Rob L

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Re: LC interest rates updated 5/8/2018
« Reply #6 on: May 13, 2018, 03:20:33 PM »
From LC's most recent quarterly report A grade originations were up 97% year over year! B was up 38%.
LC is certainly catering to bank's appetite.

C was down 9%. A year ago there were far more C originations than any other grade (about 2.5 times A grade).
Interestingly, D grade was up 28% while E, F and G were down 28%, 57% and 75% respectively.

The standard loan program is 76% of LC's originations.

The times they are a'changin!