Item 1. Business
Introduction
LendingClub was incorporated in Delaware on October 2, 2006, and is currently the largest provider of unsecured personal loans in the US. We operate America’s largest online lending marketplace platform that connects borrowers and investors. LendingClub provides tools that help Americans save money on their path to financial health through lower borrowing costs and a seamless, technology-driven user experience. Investors provide capital to enable the funding of loans in exchange for earning competitive risk adjusted returns. Our marketplace enables efficient credit decisioning, pricing, servicing and support operations. We operate fully online with no traditional branch infrastructure. Our vision is to expand our marketplace model and support it with a bank charter, which we believe will be both strategically and financially accretive to the Company.
On February 18, 2020, the Company and Radius Bancorp, Inc. (Radius) entered into an Agreement and Plan of Merger, by and among the Company, a wholly owned-subsidiary of the Company, and Radius, pursuant to which the Company will acquire Radius and thereby acquire its wholly-owned subsidiary, Radius Bank (the Merger), in a cash and stock transaction valued at $185 million (of which $138.75 million is in cash and $46.25 million is in stock), plus certain purchase price and expense adjustments of up to $22 million. The closing of the Merger is subject to regulatory approval and other customary closing conditions, which the Company anticipates can be completed within 15 months, as well as customary transaction costs. The Company believes that acquiring Radius and operating with a national bank charter will enhance LendingClub’s ability to serve its members, grow its market opportunity, increase and diversify revenue and earnings, and provide both funding resilience and regulatory clarity. With the talent, infrastructure and capabilities Radius possesses, the Company intends to enhance customer engagement by offering a broader range of member products and services aimed at supporting members and improving their financial health.
In order to facilitate compliance with federal banking regulations by the Company’s largest stockholder, Shanda Asset Management Holdings Limited and its affiliates (Shanda), on February 18, 2020, the Company entered into a Share Exchange Agreement pursuant to which Shanda will exchange, subject to certain closing conditions, all shares of the Company’s common stock held by Shanda for newly issued non-voting convertible preferred stock, series A (the Exchange). In connection with the Exchange, the Company will provide Shanda registration rights and a one-time cash payment of approximately $50 million. To deter future ownership positions in the Company’s securities in excess of thresholds set forth by the Federal Reserve under the Bank Holding Company Act, the Company adopted a Temporary Bank Charter Protection Agreement (the Charter Protection Agreement) which provides for the dilution of any person or group of persons that acquires: (i) 25% or more equity interest in the Company, or (ii) 7.5% or more of any class of the Company’s voting securities, which threshold shall automatically increase to 10% in connection with the closing of the Exchange. The Charter Protection Agreement is effective as of February 18, 2020, and will automatically expire on the earlier of the closing of the Merger or 18 months.
Our mission
We provide tools that help Americans save money on their path to financial health through lower borrowing costs and a seamless, technology-driven user experience. We help investors efficiently generate competitive risk-adjusted returns through diversification.
Our strategy
Our strategy is to increase member engagement with LendingClub’s marketplace and leverage that engagement to offer a broad range of products and services from LendingClub and its partners.
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Through sustained innovation and investment in demand generation and conversion, LendingClub has already built the leading unsecured personal loan marketplace with rapid decisioning and high member satisfaction. There are two parts to our strategy:
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Visitor to Member: aims to increase member engagement with LendingClub through a member center, which is intended to give members current data on their financial health.
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Product to Platform: aims to leverage member engagement by presenting offers from LendingClub and its partners that may save members money.
We believe our strategy will generate more savings for members, provide more avenues for LendingClub to serve borrowers and investors, and grow the lifetime value of our customer base through increased revenue per member and lower member acquisition costs.
Our market opportunity
LendingClub is the market leader in unsecured personal loans in the United States, a $160 billion industry in 2019. In the United States, unsecured personal loans are the fastest growing segment of consumer credit as consumers seek to refinance record levels of revolving credit card debt, with decade high variable interest rates, and are searching online for convenient ways to get better fixed rates. According to TransUnion, “FinTech loans now (2019) comprise 38% of all unsecured personal loan balances.” That’s up significantly from just 5% of outstanding balances in 2013.
LendingClub helps customers find an easier, less expensive path to paying down debt by replacing variable high-interest credit card payments with fixed lower-rate loans and predictable, more affordable payments. With LendingClub loans, members have the potential to save thousands of dollars compared to traditional credit cards. Researchers at the Philadelphia Federal Reserve Bank have analyzed LendingClub data and concluded that we’re operating in areas where banks are closing their branches, improving pricing and the quality of credit decisioning, and increasing financial inclusion.
With 160M+ US consumers currently using digital banking, LendingClub’s online platform is well positioned for growth by empowering customers to make better financial decisions that result in improved money management and savings.
Our competitive advantages
The lending industry is highly competitive, rapidly changing, highly innovative and subject to regulatory scrutiny and oversight. We compete against a wide range of financial products and companies that attract borrowers and/or investors.
With respect to borrowers, we primarily compete with other online consumer lending marketplaces and traditional financial institutions, such as banks, credit unions, and credit card issuers. LendingClub’s key competitive advantages include:
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Price efficiency: our marketplace model generates savings for borrowers by matching them with the lowest available cost of capital provided by investors.
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Marketing efficiency: our broad spectrum of investors, innovation and returning members enable us to serve more borrowers and enhance our marketing efficiency.
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Scale, data and innovative technology: our innovative technology and online platform enables us to generate and convert demand efficiently and at scale, while managing price and credit risk effectively.
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With respect to investors, we primarily compete with other investment vehicles and asset classes, such as equities, bonds and short-term fixed income securities. LendingClub’s key competitive advantages include:
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Generating competitive risk-adjusted returns efficiently: the nature of the asset class available through, and the scale of, our marketplace platform enables us to efficiently generate competitive risk-adjusted returns for investors.
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Portfolio diversification: unsecured personal loans can offer duration, geographic and/or asset diversification to investors.
We continue to be innovative to extend these competitive advantages.
In addition to the discussion in this section, see “Item 1A.
Item 1A. Risk Factors
You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K (Report), including the section titled “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes. While we believe the risks and uncertainties described below include all material risks currently known by us, it is possible that these may not be the only ones we face. If any of the risks actually occur, our business, financial condition, operating results and prospects could be materially and adversely affected.
RISKS RELATED TO OUR BUSINESS AND REGULATION
If we are unable to maintain our relationships with issuing banks, our business will suffer.
We rely on issuing banks to originate all loans and to comply with various federal, state and other laws, as discussed more fully above in “Item 1. Business.”
Our agreements with WebBank are non-exclusive and do not prohibit WebBank from working with our competitors or from offering competing services. WebBank currently offers loan programs through other online lending marketplaces and other alternative lenders. WebBank could decide that working with us is not in its interest or could decide to enter into exclusive or more favorable relationships with our competitors. In addition, WebBank may not perform as expected under our agreements, including potentially being unable to accommodate our projected growth in loan volume. We could in the future have disagreements or disputes with WebBank or other issuing banks, which could negatively impact or threaten our relationship. As a result of our efforts to obtain a bank charter, our relationships with one or more of our issuing banks could change or negatively impact our business and operations.
WebBank is subject to oversight by the FDIC and the State of Utah and must comply with complex rules and regulations, licensing and examination requirements, including requirements to maintain a certain amount of regulatory capital relative to its outstanding loans. We are a service provider to WebBank, and as such, we are subject to audit by WebBank in accordance with FDIC guidance related to management of third-party vendors. We are also subject to the examination and enforcement authority of the FDIC as a bank service company covered by the Bank Service Company Act. We have indemnification obligations and exposure under our agreements with WebBank, including with respect to our compliance with certain applicable laws. If WebBank were to suspend, limit or cease its operations or our relationship with WebBank were to otherwise terminate, we would need to implement a substantially similar arrangement with another issuing bank, obtain additional state licenses or curtail our operations. Our agreement with WebBank has an initial term ending in January 2023 and renews automatically for two successive terms of one year each, unless either party provides notice of non-renewal to the other party in accordance with the provisions of the agreement. As of the date of this Report, no backup issuing banks have originated any loans facilitated through our marketplace and we do not have a backup origination arrangement.
We believe that our relationship with WebBank is critical to our current business model. If we are unsuccessful in maintaining our relationships with WebBank, our ability to provide loan products could be materially impaired and our operating results would suffer. If we need to enter into alternative arrangements with a different issuing bank to replace our existing arrangements, we may not be able to negotiate a comparable alternative arrangement. Transitioning loan originations to a new issuing bank is untested and may result in delays in the issuance of loans or, if our platform becomes inoperable, may result in our inability to facilitate loans through our platform. If we were unable to enter in an alternative arrangement with a different issuing bank, we would need to obtain or activate a state license in each state in which we operate to enable us to originate loans, as well as comply with other state and federal laws, which would be costly, time-consuming and may necessitate that we materially alter our business and operations.
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We are pursuing a potentially transformational transaction, which is subject to regulatory approvals and other closing conditions and, during the closing period, necessitated the adoption of a temporary bank charter protection agreement which may diminish interest in our stock. If consummated, the transaction will subject us to significant additional regulation.
As previously disclosed, we believe a bank charter will improve our capital efficiency and generate higher revenues, margins and return on equity by: (i) recapturing significant revenue which is currently going to issuing banks, (ii) reducing the use of higher cost warehouse lines, and (iii) generating additional and recurring net interest income. Accordingly, our management, with the support of the board of directors (Board), has been working diligently on obtaining a bank charter through either the establishment of a new bank through a “de novo process” or by means of an acquisition.
On February 18, 2020, we entered into a definitive agreement to acquire Radius Bancorp, Inc. (Radius), a savings and loan holding company (the Transaction). As part of the Transaction, we will acquire Radius’ wholly-owned subsidiary, Radius Bank, a federal savings association, which will convert to a national bank simultaneously with the Transaction. We believe that the Transaction has the potential to be transformational for the Company by enabling us to add additional benefits, products and/or functionality to the LendingClub platform which may, among other things, facilitate our ability to develop and maintain a longer-term relationship with our customers. Additionally, we believe the Transaction would provide access to a new source of relatively lower cost funding to our marketplace and give our business greater resilience and regulatory certainty.
However, closing the Transaction is subject to regulatory approvals and other customary closing conditions which we believe will take some time to completely satisfy. The satisfaction of all of the required conditions could delay the completion of the Transaction for a significant period of time or prevent it from occurring. Any delay in completing the Transaction could cause us not to realize some or all of the benefits mentioned above that we expect to achieve if the Transaction is successfully completed within its expected time frame. Further, there can be no assurance that the required regulatory approvals necessary to complete the Transaction will be obtained, or whether all of the other conditions to the closing of the Transaction will be satisfied or waived or that the Transaction will be completed.
In particular, the Transaction is subject to regulatory approvals, including approvals from the Federal Reserve and the Office of the Comptroller of the Currency (the OCC) under the Bank Holding Company Act and the National Bank Act, respectively.
The Federal Reserve is prohibited from approving any merger transaction under Section 3 of the Bank Holding Company Act that would have anti-competition effects, unless the Federal Reserve finds that the anti-competitive effects of the merger transaction are clearly outweighed in the public interest by the probable effect of the merger transaction in meeting the convenience and needs of the communities to be served. In addition, among other things, in reviewing the Transaction, the Federal Reserve must consider (i) the financial condition and future prospects, as applicable, of the resulting organization; (ii) the competence, experience, and integrity of the officers, directors and principal stockholders, as applicable, of the resulting organization; (iii) the convenience and needs of the communities to be served, including any record of performance under the Community Reinvestment Act of 1977, as amended (the CRA); (iv) the Company’s and Radius’ effectiveness in combating money-laundering activities; and (v) the risk to the stability of the United States banking or financial system presented by the Transaction.
In connection with Radius Bank’s conversion to a national bank and other matters that may require OCC approval, the OCC will consider (i) Radius Bank’s financial condition, management, and regulatory capital requirements; (ii) Radius Bank’s conformance with statutory and regulatory criteria, including maintaining a safe and sound banking system, encouraging fair access to financial services, ensuring compliance with laws and regulations, and promoting fair treatment of customers; (iii) whether Radius Bank has obtained all necessary regulatory and shareholder or member approvals; (iv) adequacy of Radius Bank’s policies, practices, and procedures; and (v) CRA record of performance.
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The process for obtaining all the required regulatory approvals has become substantially more difficult since the global financial crisis, and our ability to obtain the requisite approvals for the Transaction depends on the bank regulators’ views as to the Company or Radius’ capital levels, quality of management, and overall condition, in addition to their assessment of a variety of other factors, including the Company and Radius’ compliance with law. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to existing or new regulatory issues we or Radius has, or may have, with regulatory agencies, including, without limitation, issues related to Bank Secrecy Act compliance, CRA issues, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive, or abusive acts or practices regulations and other similar laws and regulations. If the regulators impose conditions on the completion of the Transaction or require changes to the terms of the Transaction, such conditions or changes could have the effect of delaying or preventing completion of the Transaction or imposing additional costs on or limiting the revenues of the Company following the Transaction, any of which might have an adverse effect on the Company following the Transaction. Regulatory approvals could also be adversely impacted based on the status of any ongoing investigation of us or Radius or either party’s customers, including subpoenas to provide information or investigations by a federal, state or local governmental agency. We cannot guarantee that we will be able to obtain all required regulatory approvals, the timing of those approvals or whether any conditions will be imposed.
In order to obtain the requisite regulatory approvals, we need to develop a financial and bank capitalization plan and may need to enhance our governance, compliance, controls and management infrastructure and capabilities to be compliant with all applicable regulations and operate to the satisfaction of the banking regulators before we close the Transaction, which may require substantial time, monetary and human resource commitments. If we are not successful in developing a financial and bank capitalization plan or enhancing, as needed, our governance, compliance, controls and management infrastructure and capabilities, our ability to close the Transaction and obtain a bank charter and/or bank functionality through other avenues may be jeopardized.
Ultimately, if the Transaction does not close for any reason, including due to failure to obtain the necessary regulatory approvals or complete the exchange with Shanda described below, and we are unable to find an alternative pathway to obtaining a bank charter and/or bank functionality, then our ability to offer a broader range of products and services, and our stock price, may be adversely affected. Our stock price may also decline to the extent that the current market price reflects a market assumption that the Transaction will be completed. In addition, we would have to recognize the substantial expenses in connection with the negotiation and completion of the Transaction without realizing the expected benefits of the Transaction.
Further, if the Transaction closes, we will become subject to the Bank Holding Company Act and its restrictions and requirements, including capital requirements and shareholder requirements. We will become subject to the supervision and regulation by the Federal Reserve as well as other federal bank regulators. Our efforts to comply with such additional regulation may require substantial time, monetary and human resource commitments. If any new regulations or interpretations of existing regulations to which we are subject impose requirements on us that are impractical or that we cannot satisfy, our ability to offer a broader range of products and services, and our stock price, may be adversely affected.
Additionally, should the Transaction close, certain of our stockholders may need to comply with applicable federal banking regulations, including the applicable provisions of the Bank Holding Company Act. Specifically, stockholders holding above 9.9% of the Company’s voting interests may be required to provide certain information and/or commitments on a confidential basis to, among other regulators, the Federal Reserve. In connection with the execution of the definitive agreement for the Transaction and in order to facilitate the regulatory approvals of the Transaction, as well as to avoid the incurrence of the informational obligations for stockholders holding above 9.9% of the Company’s voting interests, we entered into an agreement whereby our largest stockholder, Shanda Asset Management Holdings Limited and its affiliates (collectively, Shanda), will exchange, subject to certain closing conditions, all shares of our common stock held by Shanda for newly issued non-voting convertible preferred stock. In connection with the exchange, the Company will provide Shanda registration rights and a one-time cash payment. In an effort to protect the Company’s ability to obtain the necessary bank regulatory approvals without the support or assistance of another stockholder, the Board approved the adoption of a Temporary Bank Charter
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Protection Agreement (the Charter Protection Agreement). The Charter Protection Agreement is designed to deter ownership positions in the Company’s stock in excess of certain thresholds set forth by the Federal Reserve under the Bank Holding Company Act by diluting any stockholder who amasses an ownership position in excess of such thresholds without the Company’s approval. To ensure the arrangement is tailored to protect the Company and does not unduly infringe on the rights of stockholders, the rights distributed pursuant to the Charter Protection Agreement shall automatically be redeemed upon the earlier of 18 months after its adoption or the close of the Transaction. Nonetheless, the Charter Protection Agreement may deter certain existing or potential stockholders from purchasing shares of the Company’s common stock, which may suppress demand for the stock and cause the price to decline.
Substantial and increasing competition in our industry may harm our business.
The lending industry is increasingly competitive. We compete with financial products and companies that attract borrowers, investors or both, as described in “Item 1. Business - Our competitive advantage.”
Many of our competitors have significantly greater financial resources and may have access to less expensive capital than we do, and may offer a broader range of products, services or features, assume a greater level of risk, have lower operating or financing costs, or have different profitability expectations than us. Certain competitors may be able to offer lower rates to borrowers than we are able to offer and/or structure their products in a manner that is more attractive to potential borrowers and investors. Additionally, some of our competitors may also be subject to less burdensome licensing and other regulatory requirements.
If we do not offer, price and develop attractive products and services for our borrowers and investors, we may not be able to compete effectively against our competitors and our business and results of operations may be materially harmed.
We are regularly subject to litigation, and government and regulatory investigations, inquiries and requests.
We are regularly subject to claims, individual and class action lawsuits, lawsuits alleging regulatory violations such as the Telephone Consumer Protection Act (TCPA), Fair Credit Reporting Act (FCRA), Unfair and Deceptive Acts and Practices (UDAP) or Unfair, Deceptive or Abusive Acts or Practices (UDAAP) violations, government and regulatory exams, investigations, inquiries or requests, and other proceedings involving consumer protection, privacy, labor and employment, intellectual property, privacy, data protection, information security, securities, tax, commercial disputes, record retention and other matters. The number and significance of these claims, lawsuits, exams, investigations, inquiries and requests have increased as our business has expanded in scope and geographic reach, and our products and services have increased in complexity. We are also subject to significant litigation and regulatory inquiries, as discussed more fully in “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 19. Commitments and Contingencies,” below. In particular, note that on April 25, 2018, the Federal Trade Commission (FTC) filed a complaint in the Northern District of California (FTC v. LendingClub Corporation, No. 3:18-cv-02454) alleging causes of action for violations of the Federal Trade Commission Act of 1914, as amended, including claims of deception in connection with disclosures related to the origination fee associated with loans available through the Company’s platform, and in connection with communications relating to the likelihood of loan approval during the application process, and a claim of unfairness relating to certain unauthorized charges to borrowers’ bank accounts. The FTC’s complaint also alleged a violation of the Gramm-Leach-Bliley Act regarding the Company’s practices in delivering its privacy notice.
The scope, timing, outcome, consequences and impact of claims, lawsuits, proceedings, investigations, inquiries and requests that we are subject to cannot be predicted with certainty. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. Furthermore, resolution of such claims, lawsuits, proceedings, investigations, inquiries and requests could result in substantial fines and penalties, which may materially and adversely affect our business. These claims, lawsuits, proceedings, exams, investigations, inquiries and requests could also: (i) result in reputational harm, criminal sanctions, consent decrees, orders preventing us from offering certain features, functionalities, products or services, (ii) limit the Company’s access to credit, (iii) result in a modification or suspension of our business practices (including limiting the maximum interest
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rate on certain loans facilitated through our platform and/or refraining from making certain loans available for investment by certain investors), (iv) require us to develop non-infringing or otherwise altered products or technologies, (v) prompt ancillary claims, lawsuits, proceedings, investigations, inquiries and requests, (vi) consume financial and other resources which may otherwise be utilized for other purposes, such as advancing the Company’s products and services, (vii) cause a breach or cancellation of certain contracts, or (viii) result in a loss of borrowers, investors and/or ecosystem partners, any of which may adversely affect our business and operations. Furthermore, even following the resolution of any claims, lawsuits, proceedings, exams, investigations, inquiries and requests against the Company, a regulatory enforcement agency could take action against one or more individuals or entities, which may require us to continue to incur significant expense for indemnification for any such individual or entity until such matters may be resolved. Any of these consequences could materially and adversely affect our business.
Holding loans on our balance sheet exposes us to credit, liquidity and interest rate risk, which may adversely affect our financial performance.
A portion of the loans facilitated through our platform are purchased by the Company for a variety of reasons, including, but not limited to: (i) to support structured program transactions, (ii) to facilitate certain whole loan sales initiatives, (iii) to enable the testing or initial launch of alternative loan terms, programs or channels, and (iv) to mitigate marketplace imbalances on our platform for limited grades or terms, which arise when there is insufficient investor demand for certain loans available for purchase.
We may hold loans purchased by the Company for a short period or for a longer term. While these loans are on our balance sheet we earn interest on the loans, but we have exposure to the credit risk of the borrowers. In the event of a decline or volatility in the credit profile of these borrowers the value of these held loans may decline. This may adversely impact the liquidity of these loans, which could produce losses if the Company is unable to realize their fair value or manage declines in their value, each of which may adversely affect our financial performance. Further, utilizing our balance sheet to purchase loans at greater than forecasted amounts may impair our ability to allocate sufficient financial resources for other purposes, such as advancing the Company’s products and services, which could impact our results of operations.
With respect to a portion of loans facilitated through our platform and purchased by the Company, including a portion of those that are purchased to mitigate marketplace imbalances for certain grades or terms from time to time, we may provide incentives to investors to purchase such loans from the Company or we may sell the loans at a price that is less than par. Any incentive or difference to par may be partially or wholly offset by other factors, such as interest earned on the loan prior to its sale. However, selling loans with incentives or at prices less than par may discourage investors from purchasing loans on our platform without incentives or at par value, cause the Company to realize less revenue than expected with respect to such loans or prompt dissatisfaction and complaints from investors unable to purchase incentivized or discounted loans, each of which may adversely affect our business and financial results.
If we are unable to develop and commercialize new products and services and enhancements to existing products and services, our business may suffer.
The lending industry is evolving rapidly and changing with disruptive technologies and the introduction of new products and services. We derive a significant portion of our revenue from transaction-based fees we collect in connection with facilitating the origination of unsecured personal loans. To enhance customer engagement and diversify our revenue streams, we are undertaking a strategy to broaden the scope of our products and services we offer. Failure to broaden the scope of our products and services leaves us dependent on a single revenue stream and vulnerable to competitors offering a suite of products and services. Accordingly, a key part of our success depends on our ability to develop and commercialize new products and services and enhancements to existing products and services.
We incur expenses and expend resources to develop and commercialize new products and services and enhancements to existing products and services. However, we may not assign the appropriate level of resources,
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priority or expertise to the development and commercialization of these new products, services or enhancements. We also could utilize and invest in technologies, products and services that ultimately do not achieve widespread adoption and, therefore, are not as attractive or useful to our customers as we anticipate. Moreover, we may not realize the benefit of new technologies, products, services or enhancements for many years, and competitors may introduce more compelling products, services or enhancements in the meantime. Competitors also may develop or adopt technologies or introduce innovations that make our lending marketplace platform less attractive to our borrowers and/or investors.
If we are unable to develop and commercialize timely and attractive products and services for our borrowers and investors, our growth may be limited and our business may be materially and adversely affected.
A disruption or failure in services provided by third parties could materially and adversely affect our business.
We increasingly rely on third parties to provide and/or assist with certain critical aspects of our business, including: (i) customer support, (ii) collections, (iii) loan origination, (iv) data verification and (v) cloud computing. These third parties may be subject to cybersecurity incidents, privacy breaches, service disruptions and/or financial, legal, regulatory, labor or operational issues; any of which may result in the third party providing inadequate service levels to us or our customers. In addition, these third parties may breach their agreements with us and/or refuse to continue or renew these agreements on commercially reasonable terms. If any third party provides inadequate service levels or fails to provide services at all, we may face business disruptions, customer dissatisfaction, reputational damage and/or financial and legal exposure; any of which may harm our business.
If the loans facilitated through our lending marketplace were found to violate a state’s usury laws, and/or we were found to be the true lender (as opposed to our issuing bank(s)), we may have to alter our business model and our business could be harmed.
The interest rates that are charged to borrowers and that form the basis of payments to investors through our lending marketplace are enabled by legal principles including (i) the application of federal law to enable an issuing bank that originates the loan to “export” the interest rates of the jurisdiction where it is located, (ii) the application of common law “choice of law” principles based upon factors such as the loan document’s terms and where the loan transaction is completed to provide uniform rates to borrowers, or (iii) the application of principles that allow the transferee of a loan to continue to collect interest as provided in the loan document. WebBank, the primary issuing bank of the loans facilitated through our lending marketplace, is chartered in, and operates out of, Utah, which allows parties to generally agree by contract to any interest rate. Certain states, including Utah, have no statutory interest rate limitations on personal loans, while other jurisdictions have a maximum rate. In some jurisdictions, the maximum rate is less than the current maximum rate offered by WebBank through our platform. If the laws of such jurisdictions were found to govern the loans facilitated through our lending marketplace (in conflict with the principles described above), those loans could be in violation of such laws.
We operate in a complex and evolving regulatory environment at the federal and state level and although we strive to work with federal, state and local regulatory agencies to help them understand our model and its benefits for consumers, our issuing bank partnership model may be deemed to be inappropriate for certain of the jurisdictions in which we operate. Specifically, note that as discussed in “Item 1. Business - Regulatory and Compliance Framework” above, in May 2015, the U.S. Court of Appeals for the Second Circuit issued its decision in Madden v. Midland Funding, LLC that interpreted the scope of federal preemption under the National Bank Act (NBA) and held that a nonbank assignee of a loan originated by a national bank was not entitled to the benefits of federal preemption of claims of usury. The Second Circuit’s decision is binding on federal courts located in Connecticut, New York, and Vermont, but the decision could also be adopted by other courts. While we believe that our program is factually distinguishable from such case, the decision of the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC could create potential liability under state statutes such as usury and consumer protection statutes.
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In addition, there have been (and may continue to be) regulatory inquiries and/or litigation challenging lending arrangements where a bank or other third-party has made a loan and then sells and assigns it to an entity that is engaged in assisting with the origination and servicing of a loan. See “Item 1. Business - Regulatory and Compliance Framework” above for more information.
If a borrower or a state were to successfully bring claims against us for state usury law violations, and the rate on that borrower’s personal loan was greater than that allowed under applicable state law, we could be subject to fines and penalties, including the voiding of loans and repayment of principal and interest to borrowers and investors, and may be in breach of certain representation and warranties we make to our platform investors. In some states, we have decided to limit the maximum interest rate on loans facilitated through our platform. Additionally, we might decide to further modify or suspend certain of our business practices, including limiting the maximum interest rate on certain loans facilitated through our platform and/or refraining from making certain loans available for investment by certain investors, and we might decide to originate loans under state-specific licenses, where such a ruling is applicable. These actions could adversely impact our business. Further, if we were unable to partner with another issuing bank or obtain a bank charter, we would have to substantially modify our business operations from the manner currently contemplated and would be required to maintain state-specific licenses and only provide a limited range of interest rates for personal loans, all of which would substantially reduce our operating efficiency and attractiveness to investors and may materially adversely affect our business, financial condition and results of operations.
The regulatory framework for our business is complex, evolving and uncertain as federal and state governments consider new laws to regulate online lending marketplaces such as ours.
The regulatory framework for online lending marketplaces such as ours is evolving and uncertain. It is possible that new laws and regulations will be adopted in the United States and internationally, or existing laws and regulations may be interpreted in new ways, that would affect the operation of our lending marketplace and the way in which we interact with borrowers and investors. Furthermore, the costs associated with staying current and complying with the regulatory framework may divert significant resources which otherwise might be utilized for other purposes, such as advancing the Company’s products and services, which could negatively impact our results of operations. For a discussion of how government regulation impacts key aspects of our business, see “Item 1. Business - Regulatory and Compliance Framework.”
Any failure or perceived failure to comply with existing or new laws, regulations, or orders of any government authority (including changes to or expansion of the interpretation of those laws, regulations, or orders), including those discussed in this risk factor, may subject us to significant fines, penalties, criminal and civil lawsuits, forfeiture of significant assets, and enforcement actions in one or more jurisdictions; result in additional compliance and licensure requirements; cause us to lose existing licenses or prevent or delay us from obtaining additional licenses that may be required for our business; increase regulatory scrutiny of our business; restrict our operations; and/or force us to change our business practices, make product or operational changes, or delay planned transactions, product launches or improvements. Any of the foregoing could, individually or in the aggregate, harm our reputation, damage our brands and business, and adversely affect our results of operations and financial condition.
While we have developed policies designed to assist in compliance with these laws and regulations, no assurance can be given that these policies will be effective in preventing violations of these laws and regulations and there can be no assurance that we will not violate such laws and regulations.
Consumer Financial Protection Bureau
As discussed in “Item 1. Business - Regulatory and Compliance Framework” above, the CFPB previously announced that it intends to expand its supervisory authority through the use of “larger participant rules.” The CFPB has not announced specifics regarding its proposed rulemaking, and recently announced that it intends to review its
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policies and priorities. Consequently, there continues to be uncertainty as to how the CFPB’s strategies and priorities, including any final rules, will impact our businesses and results of operations going forward.
State Regulatory Framework
As discussed in “Item 1. Business - Regulatory and Compliance Framework” above, at the state level, certain states are considering the scope of their regulation and oversight of the financial technology industry. The application of state laws to our business, including the application of usury laws, now or as they may be written or interpreted in the future, could have a significant impact on our ability to do business in any given state and may impact our business and results of operations going forward.
Federal and State Consumer Protection Laws
As discussed in “Item 1. Business - Consumer Protection Laws” above, we and our issuing bank partners must comply with regulatory regimes, including those applicable to consumer credit transactions, various aspects of which are untested as applied to our lending marketplace. Certain state laws generally regulate interest rates and other charges and require certain disclosures. In addition, other federal and state laws may apply to the origination and servicing of loans facilitated through our lending marketplace and to communications with or to customers or prospective customers.
Banking Regulations
As disclosed above, we are pursuing a Transaction which, if closed, will result in the Company becoming subject to the Bank Holding Company Act and its restrictions and requirements, including capital requirements and shareholder requirements. In addition, we would become subject to supervision and regulation by the Federal Reserve, as well as other federal bank regulators. We will need to develop a financial and bank capitalization plan and may need to enhance certain of our governance, compliance, controls and management infrastructure and capabilities to be compliant with all applicable regulations and to the satisfaction of the banking regulators. If we are not successful in developing and remaining compliant with a financial and bank capitalization plan and enhancing our governance, compliance, controls and management infrastructure and capabilities, our ability to close the Transaction, obtain a bank charter and/or bank functionality through other avenues, and/or maintain a bank charter may be jeopardized.
Other Regulations
As discussed in “Item 1. Business - Consumer Protection Laws” above, we and our issuing bank partners must comply with regulatory regimes, including those applicable to consumer credit transactions, various aspects of which are untested as applied to our lending marketplace. Certain state laws generally regulate interest rates and other charges and require certain disclosures. In addition, other federal and state laws may apply to the origination and servicing of loans facilitated through our lending marketplace.
In particular, the USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with FinCEN. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts and monitoring their transactions. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently several banking institutions have received large fines for non-compliance with these laws and regulations.
Failure to comply with these laws and regulatory requirements applicable to our business may, among other things, limit our or a collection agency’s ability to collect all or part of the principal of or interest on loans. As a result, we may not be able to collect our servicing fee with respect to the uncollected principal or interest, and investors may be discouraged from investing in loans. In addition, non-compliance could subject us to damages, revocation of
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required licenses, class action lawsuits, administrative enforcement actions, rescission rights held by investors in securities offerings and civil and criminal liability, which may harm our business and our ability to maintain our lending marketplace and may result in borrowers rescinding their loans.
State Licensing Requirements
Where applicable, we will seek to comply with state small loan, lender, solicitation, credit service organization, loan broker, servicing and similar statutes. In U.S. jurisdictions with licensing or other requirements that we believe may be applicable to us, we believe we comply with or are exempt from the relevant requirements through the operation of our lending marketplace with issuing banks and/or licenses that we possess or will seek to obtain. Although we periodically evaluate the need for licensing in various jurisdictions, there is a risk that, at any given time, we will not have the necessary licenses to operate in all relevant jurisdictions or that we will be in full compliance with all applicable requirements. If we are found to not have complied with applicable laws, regulations or requirements, we could: (i) lose one or more of our licenses or authorizations, (ii) become subject to a consent order or administrative enforcement action, (iii) face lawsuits (including class action lawsuits), sanctions or penalties, (iv) be in breach of certain contracts, which may void or cancel such contracts, (v) decide or be compelled to modify or suspend certain of our business practices (including limiting the maximum interest rate on certain loans facilitated through our platform and/or refraining from making certain loans available for investment by certain investors), or (vi) be required to obtain a license in such jurisdiction, which may have an adverse effect on our ability to continue to facilitate loans through our lending marketplace, perform our servicing obligations or make our lending marketplace available to borrowers in particular states; any of which may harm our business.
If the credit decisioning, pricing, loss forecasting and scoring models we use contain errors, do not adequately assess risk, or are otherwise ineffective, our reputation and relationships with borrowers and investors could be harmed, our market share could decline and the value of loans held on our balance sheet may be adversely affected.
Our ability to attract borrowers and investors to, and build trust in, our lending marketplace is significantly dependent on our ability to effectively evaluate a borrower’s credit profile and likelihood of default. To conduct this evaluation, we utilize credit decisioning, pricing, loss forecasting and scoring models that assign each loan offered on our lending marketplace a grade and a corresponding interest rate. Our models are based on algorithms that evaluate a number of factors, including behavioral data, transactional data, bank data and employment information, which may not effectively predict future loan losses. If we are unable to effectively segment borrowers into relative risk profiles, we may be unable to offer attractive interest rates for borrowers and risk-adjusted returns for investors. Additionally, if these models fail to adequately assess the creditworthiness of our borrowers, we may experience higher than forecasted losses. Furthermore, as stated above, we hold loans on our balance sheet for a variety of reasons. We periodically assess the value of these loans and in doing so we review and incorporate a number of factors including forecasted losses. Accordingly, if we fail to adequately assess the creditworthiness of our borrowers such that we experience higher than forecasted losses, the value of the loans held our balance sheet may be adversely affected.
We continually refine these algorithms based on new data and changing macro-economic conditions. However, there is no guarantee that the credit decisioning, pricing, loss forecasting and scoring models that we use have accurately assessed the creditworthiness of our borrowers, or will be effective in assessing creditworthiness in the future.
Similarly, if any of these models contain programming or other errors, are ineffective or the data provided by borrowers or third parties is incorrect or stale, our loan pricing and approval process could be negatively affected, resulting in mispriced or misclassified loans or incorrect approvals or denials of loans. If these errors were to occur, we may be obligated to repurchase the affected loans, investors may try to rescind their affected investments or decide not to invest in loans in the future or borrowers may seek to revise the terms of their loans or reduce the use of our lending marketplace for loans.
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Fraudulent activity associated with our lending marketplace could negatively impact our operating results, brand and reputation and cause the use of our products and services to decrease and our fraud losses to increase.
We are subject to the risk of fraudulent activity associated with our lending marketplace, issuing bank(s), borrowers, investors and third parties handling borrower and investor information. We have taken measures to detect and reduce the risk of fraud, but these measures need to be continually improved and may not be effective against new and continually evolving forms of fraud or in connection with new product offerings. Under our agreements with investors, we are obligated to repurchase loans in cases of confirmed identity theft. The level of our fraud charge-offs and our results of operations could be materially and adversely affected if fraudulent activity were to significantly increase. High profile fraudulent activity or significant increases in fraudulent activity could lead to regulatory intervention, negatively impact our operating results, brand and reputation and lead us to take steps to reduce fraud risk, which could increase our costs.
In addition, in the past, third parties have attempted to defraud individuals, some of whom may be potential customers of ours, by misappropriating our logos and represented themselves as LendingClub in e-mail campaigns to e-mail addresses that have been obtained outside of LendingClub. In one particular scheme, third parties represented to individuals that they might obtain a loan if they paid an “advance fee.” Individuals who believe that the campaigns are genuine may make payments to these unaffiliated third parties. Although we take commercially reasonable steps to prevent third-party fraud, we cannot always be successful in preventing individuals from suffering losses as a result of these schemes. Individuals who suffer damages due to the actions of these unaffiliated third parties may negatively view LendingClub, causing damage to our brand and reputation and reducing our business.
If we are unable to accurately forecast demand for loans, our business could be harmed.
We operate a lending marketplace for consumer credit, balancing borrower demand for loans against investor demand for risk-adjusted returns. We offer credit to borrowers across a range of credit profiles and rates and we offer investment opportunities across a range of risk-adjusted returns. In the event that borrower demand at a given credit rate exceeds investor demand for that product for a given period, we may fund the loans and hold them on our balance sheet, which carries certain risks. The vast majority of investor funding on our platform is non-committed and therefore it is challenging to precisely forecast investor demand. In addition to the discussion in this section, see “Holding loans on our balance sheet exposes us to credit, liquidity and interest rate risk, which may adversely affect our financial performance.”
Alternatively, in the event that investor demand at a given return exceeds borrower demand for that product for a given period, there may be insufficient inventory to satisfy investor demand. If investors do not believe their demand can be met on our platform, they may seek alternative investments from ours and our business may suffer.
Liquidity risk could impair our ability to manage and grow our operations, which may adversely affect our financial condition.
As stated above, a portion of the loans facilitated through our platform are purchased by us for a variety of reasons. Purchasing loans requires liquidity and therefore managing our liquidity has become essential to our business.
If we have insufficient liquidity to support loan purchases, we may undertake measures to improve liquidity, including altering operations to require less liquidity, accelerating the sale of existing loans held on our balance sheet, incurring additional indebtedness or raising additional capital. Incurring additional indebtedness and raising additional capital depend on our ability to secure funding in amounts adequate to finance our current and projected operations and on terms attractive to us, each of which could be impaired by factors specific to us or the financial markets generally. A lack of sufficient liquidity may adversely affect our financial condition by, among other things, impairing our ability to meet investor demand for structured program transactions or forcing us to alter our operations in a manner that may reduce origination volume.
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In addition, if we are required to rely more heavily on more expensive funding sources to support existing operations and/or future growth, our revenues may not increase proportionately to cover our costs which may adversely affect our operating margins and profitability.
Furthermore, if we obtain a bank charter, we would be required to establish and maintain significant levels of capital, which could make it more difficult to maintain sufficient liquidity to operate our business.
If we do not maintain or continue to increase loan originations facilitated through our lending marketplace, or expand our lending marketplace to new markets, we may not succeed in maintaining and/or growing our business, and as a result our business and results of operations could be adversely affected.
To maintain and continue to grow our business, we must continue to increase loan originations through our lending marketplace by attracting a large number of new borrowers who meet our platform’s lending standards and new and existing investors to invest in these loans. Our ability to attract qualified borrowers and attract new and retain existing investors each depends in large part on the success of our marketing efforts, our visibility, placement and customer reviews on third-party platforms, and the competitive advantage of our products, particularly as we continue to grow our lending marketplace and introduce new products. If any of our marketing channels become less effective, or the cost of these channels were to significantly increase, we may not be able to attract new borrowers and attract new and retain existing investors in a cost-effective manner or convert potential borrowers and investors into active borrowers and investors in our lending marketplace. Additionally, changes in the way third-party platforms operate, including changes in our participation on such platforms, could make the maintenance and promotion of our products and services, and thereby maintaining and growing loan originations, more expensive or more difficult.
If there are not sufficient qualified loans facilitated on the platform, investors may be unable to deploy their capital in a timely or efficient manner and may seek other investment opportunities. If the performance of loans facilitated through our platform is lower than expected, we may be unable to attract new and retain existing investors. If there is insufficient investor participation, borrowers may be unable to obtain investment capital for their loans and may stop using our lending marketplace for their borrowing needs, which will impact our business results. If loan originations through our platform decrease, for any reason, our business and financial results may be adversely affected. Furthermore, if we restructure our products, including lowering or eliminating our transaction fees, our financial results may be adversely affected even if we are able to maintain or increase loan originations through our platform.
A small number of investors, including LendingClub, account for a large dollar amount of investment through our lending marketplace and if these investors pause or cease their participation or exert influence over us, our business, financial condition and results of operations may be harmed.
A small number of loan investors, including the Company, account for a large dollar amount of capital on our platform. See “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Investments in Quarterly Originations by Investment Channel and Investor Concentration” for further discussion of and information regarding our investor concentration.
Our success depends in significant part on the financial strength of investors participating on our lending marketplace. Investors could, for any reason, experience financial difficulties and cease participating on our lending marketplace or fail to pay fees when due. The occurrence of one or more of these events with a significant number of investors could, alone or in combination, have a material and adverse effect on our business, financial condition and results of operation.
Additionally, investors may exert significant influence over us, our management and operations. For example, if investors other than the Company pause or discontinue their investment activity, we may need to provide incentives or discounts and/or enter into unique structures or terms to attract investor capital to the platform. These arrangements may have a number of different structures and terms, including alternative fee arrangements or other
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inducements. There is also no assurance that we will be able to enter into any of these transactions if necessary, or if we do, what the final terms will be. Failure to attract investor capital on reasonable terms may result in us having to use additional capital to invest in loans or reduce origination volume. Such actions may have a material impact on our business, financial condition and results of operations.
A decline in social and economic conditions may adversely affect our customers, which may negatively impact our business and results of operations.
As a lending marketplace, we believe our customers are highly susceptible to uncertainties and negative trends in the markets driven by, among other factors, general social and economic conditions in the United States and abroad. Economic factors include interest rates, unemployment levels, the impact of a federal government shutdown, natural disasters, gasoline prices, adjustments in monthly payments, adjustable-rate mortgages and other debt payments, the rate of inflation, relative returns available from competing investment products and consumer perceptions of economic conditions. Social factors include changes in consumer confidence levels and changes in attitudes with respect to incurring debt and the stigma of personal bankruptcy.
These social and economic factors may affect the ability or willingness of borrowers to make payments on their loans. Because we make payments to investors ratably only to the extent we receive the borrower’s payments on the corresponding loan, if we do not receive payment(s) on the corresponding loan, the investor will not be entitled to the corresponding payment(s) under the terms of the investment or whole loan purchase agreement. In some circumstances, economic and/or social factors could lead to a borrower deciding to pre-pay his or her loan obligation. In the event of a prepayment, while the investor would receive the return of principal, interest would no longer accrue on the loan. Accordingly, the return for the investor would decline as compared to a loan that was timely paid in accordance with the amortization schedule. There is no penalty to borrowers if they choose to pay their loan early.
We strive to establish a lending marketplace in which annual percentage rates are attractive to borrowers and returns, including the impact of credit losses and prepayments, are attractive to investors. These external economic and social conditions and resulting trends or uncertainties could also adversely impact our customers’ ability or desire to participate on our platform as borrowers or investors, which could negatively affect our business and results of operations. In addition to the discussion in this section, see “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Current Economic and Business Environment.”
Our growth depends in part on the success of our strategic relationships with third parties.
In order to grow our business and effectuate our product to platform strategy, we anticipate that we will depend in part on our ability to develop and expand our strategic relationship with third parties to offer additional products and services on our platform.
Identifying suitable partners, and negotiating and documenting relationships with them, requires significant time and resources. In some cases, we also compete directly with our partners’ product offerings, and if these partners cease their strategic relationship with us it could result in fewer product and service offerings on our platform, which may impede our ability to execute on our product to platform strategy. Further, if we are unsuccessful in establishing or maintaining our relationships with third parties, or realizing the anticipated benefits from such partnerships, our ability to compete and to grow our revenue could be impaired and our operating results may suffer.
If collection efforts on delinquent loans are ineffective or unsuccessful, the return on investment for investors in those loans would be adversely affected and investors may not find investing through our lending marketplace desirable.
With the exception of our auto loan products and certain small business loan products, loans facilitated on our platform are unsecured obligations of borrowers, and they are not secured by any collateral. None of the loans facilitated on our platform are guaranteed or insured by any third party nor backed by any governmental authority in
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any way. We are the loan servicer for all loans supporting notes, all certificates and certain secured borrowings, and we are the loan servicer for most, though not all, loans sold as whole loans. The ability to collect on the loans is dependent on the borrower’s continuing financial stability, and consequently, collections can be adversely affected by a number of factors, including job loss, divorce, death, illness, personal bankruptcy or the economic and/or social factors referenced above. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. Accordingly, we and our designated third-party servicers and collection agencies are limited in our ability to collect loans.
In addition, most investors must depend on LendingClub or our third-party servicers and collection agents to pursue collection on delinquent borrower loans. We generally use our in-house collections department as a first step when a borrower misses a payment. Because we make payments ratably on an investor’s investment only if we receive the borrower’s payments on the corresponding loan, if we, or third parties on our behalf, cannot adequately perform collection services, the investor will not be entitled to any payments under the terms of the investment. In the event that our initial in-house attempts to contact a borrower are unsuccessful, we generally refer the delinquent account to the outside collection agent. Further, if collection action must be taken in respect of a loan, we or the collection agency may charge a collection fee on any amounts that are obtained (excluding litigation). These fees will correspondingly reduce the amounts of any payments received by an investor. Similarly, the returns to investors may be impacted by declines in market rates for sales of charged-off loans to third party purchasers. Ultimately, if delinquencies impair our ability to offer attractive risk-adjusted returns for investors, they may seek alternative investments from ours and our business may suffer.
In addition, because our servicing fees depend on the collectability of the loans, if we experience a significant increase in the number of delinquent or charged-off loans we will be unable to collect our entire servicing fee for such loans and our revenue could be adversely affected.
Credit and other information that we receive from borrowers or third parties about a borrower may be inaccurate or may not accurately reflect the borrower’s creditworthiness, which may cause us to inaccurately price loans facilitated through our lending marketplace.
Our ability to review and select qualified borrowers depends on obtaining borrower credit information from consumer reporting agencies, such as TransUnion, Experian or Equifax, and other third parties and we assign loan grades to loan requests based on our lending marketplace’s credit decisioning and scoring models that take into account reported credit score, other information reported by the consumer reporting agencies and the requested loan amount, in addition to a variety of other factors. A credit score or loan grade assigned to a borrower may not reflect that borrower’s actual creditworthiness because the credit score may be based on outdated, incomplete or inaccurate consumer reporting data, and we do not verify the information obtained from the borrower’s credit report.
Additionally, there is a risk that, following the date of the credit report or other third-party data that we obtain and review, a borrower may have:
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become delinquent in the payment of an outstanding obligation;
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defaulted on a pre-existing debt obligation;
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taken on additional debt; or
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sustained other adverse financial events.
In addition, borrowers supply a variety of information that is included in the loan listings on our lending marketplace, and it may be inaccurate or incomplete. To verify a borrower’s identity, income or employment, our verification process and teams connect to various data sources, directly or through third-party service providers, contact the human resources department of the borrower’s stated employer, or request pay stubs. However, we often do not verify a borrower’s stated tenure, job title, home ownership status or intention for the use of loan proceeds.
The factors above may result in loans being issued to otherwise non-qualified borrowers and/or impact our ability to effectively segment borrowers into relative risk profiles, each of which may impair our ability to offer attractive risk-adjusted returns for investors, which may cause investors to seek alternative investments from ours and our
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business may suffer. Additionally, if borrowers default on loans that are not priced correctly because the information provided by the borrowers or third parties is inaccurate, investors may try to rescind their affected investments in these loans or the loans may not perform as expected and our reputation may be harmed.
Our ability to offer our notes depends upon our compliance with requirements under federal or state securities laws.
We issue member payment dependent notes sold pursuant to the Note Registration Statement. We qualify as a “well-known seasoned issuer,” which allows us to file automatically effective registration statements with the Securities and Exchange Commission (SEC). Under SEC rules, for certain material updates, we must file post-effective amendments, which, if we do not qualify as a “well-known seasoned issuer,” do not become effective until declared effective by the SEC. We may fail to maintain our “well-known seasoned issuer” status if we do not file SEC reports on a timely manner or for other reasons. In addition, if we fail to file our Annual Reports on Form 10-K or quarterly reports on Form 10-Q on a timely basis or are otherwise required to suspend use of a registration statement for the notes, we could be required to suspend offering of our notes until the deficiency is resolved. Because we offer notes on a continuous basis, securities law restrictions may also limit our ability to market or advertise to potential investors.
We are also currently required to register or qualify for an exemption in every state in which we offer securities. Qualification in a state can be a time-consuming process, often requiring periodic renewals. Failure to timely renew these registrations may require us to pay penalties, suspend further offerings until we regain compliance and make rescission offers in connection with previously completed investments.
Certain states in which we offer notes also impose special suitability standards and other conditions for operation in their states, restricting the persons and conditions under which we may make offerings in these states. We do not offer our notes in all states due to the restrictions of certain states. While we believe that we may now rely on federal preemption of state registration and qualification requirements, states may interpret federal law as applied to our notes differently, possibly requiring us to continue to make filings in or limit operations in those states. Regardless of any such registration, qualification or preemption, we are subject to both state and federal antifraud rules of each state in which we operate.
As a result of these requirements, actual or alleged non-compliance with federal or state laws or changes in federal or state law or regulatory policy could limit our ability to offer notes in certain states, require us to pay fines or penalties, or curtail our operations.
Fluctuations in interest rates could negatively affect transaction volume.
As of the date of this Report, all personal, auto, and small business loans facilitated through our lending marketplace are issued with fixed interest rates, and education and patient finance loans are issued with fixed or variable rates, depending on the type of loan. If interest rates rise, potential borrowers could seek to defer taking new loans as they wait for interest rates to decrease and/or settle, and borrowers of variable rate loans may be subject to increased interest rates, which could increase default risk. If interest rates decrease after a loan is made, existing borrowers may prepay their loans to take advantage of the lower rates. Furthermore, investors would lose the opportunity to collect the higher interest rate payable on the corresponding loan and may delay or reduce future loan investments. To the extent that we hold loans for sale on our balance sheet, we will be at risk to rising interest rates between origination and sale. In order to sell such loans, we may need to reduce the sale price in order to satisfy the yield expectations of our investors.
Since the most recent recession, the U.S. Federal Reserve has taken actions which have resulted in low interest rates prevailing in the marketplace for a historically long period of time. In 2018, the U.S. Federal Reserve raised its benchmark interest rate on multiple occasions. Although in 2019 the benchmark interest rate was lowered by the U.S. Federal Reserve, the interest rate environment is dynamic and interest rate increases may materially and negatively affect us, as rising interest rates could have a dampening effect on overall economic activity and/or the
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financial condition of our customers, either or both of which could negatively affect demand for our products and services.
For many reasons, including those stated above, fluctuations in the interest rate environment may discourage investors and borrowers from participating in our lending marketplace and may reduce our loan originations, which may adversely affect our business.
Any significant disruption in service on our platform or in our technology systems, including events beyond our control, could have a material adverse effect on our operations.
We believe the technology platform that powers our lending marketplace enables us to deliver solutions to borrowers and investors and provides a significant time and cost advantage over traditional banks. The satisfactory performance, reliability and availability of our technology and our underlying network infrastructure are critical to our operations, customer service and reputation. Our failure to maintain satisfactory performance, reliability and availability of our technology and our underlying network infrastructure may impair our ability to attract new and retain existing borrowers and investors, which could have a material adverse effect on our operations.
Our platform systems are mirrored between two third-party owned and operated facilities. Our primary location is in Las Vegas, Nevada and is operated by Switch, Inc. Our secondary location is located in Santa Clara, California and is operated by CenturyLink. Our operations depend on each provider’s ability to protect its and our systems in their facilities against damage or interruption from natural disasters, power or telecommunications failures, air quality issues, environmental conditions, computer viruses or attempts to harm our systems, criminal acts and similar events. If our arrangement with either provider is terminated or if there is a lapse of service or damage to their facilities, we could experience interruptions in our service as well as delays and additional expense in arranging new facilities.
Any interruptions or delays in our technology systems or service, whether as a result of third-party error, our error, natural disasters, terrorism, other man-made problems, or security breaches, whether accidental or willful, could harm our relationships with our borrowers and investors and our reputation. Additionally, in the event of damage or interruption, our insurance policies may not adequately compensate us for any losses that we may incur. Our disaster recovery plan has not been tested under actual disaster conditions, and we may not have sufficient capacity to recover all data and services in the event of an outage. These factors could prevent us from processing or posting payments on the loans, damage our brand and reputation, divert our employees’ attention, reduce our revenue, subject us to liability and cause borrowers and investors to abandon our lending marketplace, any of which could adversely affect our business, financial condition and results of operations.
We are exposed to cyber-attacks, data breaches, internal employee and other insider misconduct, computer viruses, physical and electronic break-ins and similar disruptions that may adversely impact our ability to protect the confidential information of our borrowers and our investors and that could adversely impact our reputation, business approach and financial performance.
Our business involves the collection, storage, processing and transmission of customers’ personal data, including financial information of borrowers and investors. The highly automated nature of our lending marketplace, our reliance on digital technologies and the types and amount of data collected, stored and processed on our systems make us an attractive target and subject to cyber-attacks, computer viruses, physical or electronic break-ins and similar disruptions. In addition, in certain circumstances we utilize third-party vendors, including cloud applications and services, to facilitate the servicing of borrower and investor accounts. Under these arrangements, these third-party vendors require access to certain customer data for the purpose of servicing the accounts. While we have taken steps to protect confidential information that we have access to, our security measures or those of our third-party vendors are subject to breach. These security breaches and other unauthorized access to our lending marketplace and servicing systems can result in confidential borrower and investor information being stolen and potentially used for criminal purposes. Security breaches or unauthorized access to confidential information expose us to liability related to the loss of the information, time-consuming and expensive litigation and negative publicity. Breaches of
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our security measures because of third-party action, employee error, third-party vendor error, malfeasance or otherwise, or because of design flaws in our software that are exposed and exploited, could adversely impact our relationships with borrowers and investors, and we could incur significant liability.
The techniques used to obtain unauthorized, improper or illegal access to our systems, our data or customers’ data, disable or degrade service, or sabotage systems are constantly evolving, may be difficult to detect quickly, and often are not recognized until after they have been launched against a target. Unauthorized parties can and have attempted to gain access to our systems and facilities through various means, including, among others, hacking into the systems or facilities of us or our partners or customers, or attempting to fraudulently induce our employees, partners, customers or others into disclosing user names, passwords, or other sensitive information, which may in turn be used to access our information technology systems. Certain efforts may be state-sponsored and supported by significant financial and technological resources, making them even more difficult to detect. Computer malware, viruses and hacking, phishing and denial of service attacks by third parties have become more prevalent in our industry, and have occurred on our systems in the past and may occur on our systems in the future. Although to date the Company has not suffered material costs or disruption to our business caused by any such incident, any future security breach could have a material adverse impact on our relationships with our borrowers and our reputation, business operations and financial performance.
Federal and state regulators and many federal and state regulations require notice if data security breaches involve certain personal data. The notice may be difficult to provide in a timely fashion for many reasons, including due to the complexity of gathering, verifying and analyzing relevant information. Furthermore, these mandatory disclosures regarding a security breach are costly to implement and often lead to widespread negative publicity, which may cause borrowers and investors to lose confidence in the effectiveness of our data security measures. Any security breach, whether actual or perceived, would harm our reputation, we could lose borrowers, investors and ecosystem partners and our business and operations could be adversely affected. Additionally, our insurance policies carry a self-insured retention and coverage limits, which may not be adequate to reimburse us for losses caused by security breaches, and we may not be able to collect fully, if at all, under these insurance policies.
Cyber-attacks suffered by third parties could negatively affect our business.
We utilize certain information provided by third parties to facilitate the marketing, distribution, servicing and collection of loans. A cyber-attack suffered by a third-party that provides data to us could impact our ability to market, distribute, service or collect for borrowers or investors. For example, Equifax announced a significant cyber breach that impacted millions of consumers. We utilize certain information from Equifax to allow us to market our products through pre-screened offers to qualified borrowers. If a consumer elects to “freeze” their credit data, we will not be able to access their information to make these pre-screened offers.
In addition, if consumers cease to trust credit reporting agencies or other third-party data providers because of cyber-attacks, they may be less willing to participate in borrowing or investing activities generally, which could impact our business. Further, as a result of the release of personally identifiable information from a third-party platform, we could experience an increase in fraudulent loan applications or investor accounts. Under our policies, we reimburse investors for any loan obtained as a result of a verified identity fraud and any increase in identity theft could result in increased reimbursement costs.
We may incur substantial indebtedness and any failure to meet our debt obligations could adversely affect our business.
We have and may continue to enter into arrangements pursuant to which we can incur significant indebtedness. For example, as of December 31, 2019, we had $60.0 million in debt outstanding under our Revolving Facility and $387.3 million in debt outstanding, in the aggregate, under our Warehouse Facilities. We may enter into additional financing arrangements, which could increase the aggregate amount of indebtedness we can incur.
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Our ability to make payments on our debt, to repay our existing indebtedness when due, and to fund our business and operations and significant planned capital expenditures will depend on our ability to pay with available cash or generate cash in the future. This, to a certain extent, is subject to financial, competitive, legislative, regulatory and other factors that are beyond our control. In addition, if we cannot service our indebtedness, we may have to take actions such as utilizing available capital, limiting the facilitation of additional loans, selling assets, selling equity or reducing or delaying capital expenditures, strategic acquisitions, investments and alliances, any of which could impede the implementation of our business strategy, prevent us from entering into transactions that would otherwise benefit our business and/or negatively affect our business. We also may not be able to refinance our indebtedness or take such other actions, if necessary, on commercially reasonable terms, or at all.
Furthermore, as stated earlier, we have and may increasingly securitize assets and offer other similar structured instruments, such as our CLUB Certificate product. To support these offerings and other initiatives, we have and will likely continue to use credit facilities to finance the purchasing and holding of loans on our balance sheet, to ultimately be used in connection with such offerings and initiatives. If, however, we are unable to consummate these types of offerings or other initiatives in accordance with our expectations, we may be required to hold loans on our balance sheet for longer than expected, or until the maturity of the loans. This may adversely impact our ability to repay our indebtedness when due and divert resources away from other projects and initiatives.
Some of our debt carries a floating rate of interest linked to the London Inter-bank Offered Rate (LIBOR). On July 27, 2017, the United Kingdom Financial Conduct Authority (FCA) announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. As a result, while the FCA and the submitting LIBOR banks have indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate, it is possible that beginning in 2022, LIBOR will no longer be available as a reference rate. In particular, the interest rate of borrowings under our Personal Loan and Auto Loan Warehouse Credit Facilities, Revolving Facility and repurchase agreements are predominately based upon LIBOR. While these agreements generally include alternative rates to LIBOR, if a change in indices results in interest rate increases on our debt, debt service requirements will increase, which could adversely affect our cash flow and operating results. Furthermore, for those agreements which do not include alternative rates to LIBOR, while we plan on working in good faith with the lenders thereto to establish an alternate benchmark rate, in the event that an agreement cannot be reached on an appropriate benchmark rate, the availability of borrowings under these agreements could be adversely impacted. At this time, the Company does not expect a materially adverse change to its financial condition or liquidity as a result of any such changes or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere.
Certain of our credit facilities have “Commitment Termination Dates,” at which point the Company’s ability to borrow additional funds ends under such facilities. We are working to amend and extend the Commitment Termination Dates of these three facilities, or to replace them with substantially similar facilities. We are also evaluating additional facilities with existing and new financial institutions. Under the respective agreements, if not amended, extended, or replaced, any outstanding debt on the Commitment Termination Dates would be repaid as an amortizing term loan, which would preclude our ability to draw additional funds from such facility and may adversely impact our ability to fund certain projects and initiatives.
From time to time we may evaluate and potentially consummate acquisitions or other strategic transactions, which could require significant management attention, disrupt our business and adversely affect our financial results.
We may evaluate and consider strategic transactions, combinations, acquisitions, dispositions or alliances. These transactions could be material to our financial condition and results of operations if consummated. If we are able to identify an appropriate business opportunity, we may not be successful in negotiating favorable terms and/or consummating the transaction and, even if we do consummate such a transaction, we may be unable to obtain the benefits or avoid the difficulties and risks of such transaction.
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Any strategic transaction, combination, acquisition, disposition or alliance will involve risks encountered in business relationships, including:
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difficulties in assimilating and integrating the operations, personnel, systems, data, technologies, products and services of the acquired business;
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inability of the acquired technologies, products or businesses to achieve expected levels of revenue, profitability, productivity or other benefits;
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difficulties in retaining, training, motivating and integrating key personnel;
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diversion of management’s time and resources from our normal daily operations;
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difficulties in successfully incorporating licensed or acquired technology and rights into our platform;
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difficulties in maintaining uniform standards, controls, procedures and policies within the combined organizations;
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difficulties in retaining relationships with customers, employees and suppliers of the acquired business;
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risks of entering markets in which we have no or limited direct prior experience;
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regulatory risks, including remaining in good standing with existing regulatory bodies or receiving any necessary pre-closing or post-closing approvals, as well as being subject to new regulators with oversight over an acquired business;
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assumption of contractual obligations that contain terms that are not beneficial to us, require us to license or waive intellectual property rights or increase our risk for liability;
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failure to successfully further develop the acquired technology;
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liability for activities of the acquired or disposed of business before the acquisition or disposition, including patent and trademark infringement claims, violations of laws, regulatory actions, commercial disputes, tax liabilities and other known and unknown liabilities;
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difficulty in separating assets and replacing shared services;
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assumption of exposure to performance of any acquired loan portfolios;
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potential disruptions to our ongoing businesses; and
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unexpected costs and unknown risks and liabilities associated with the acquisition.
We may not make any transactions, combinations, acquisitions, dispositions or alliances, or any future transactions, combinations, acquisitions, dispositions or alliances may not be successful, may not benefit our business strategy, may not generate sufficient revenue to offset the associated costs or may not otherwise result in the intended benefits. It may take us longer than expected to fully realize the anticipated benefits and synergies of these transactions, and those benefits and synergies may ultimately be smaller than anticipated or may not be realized at all, which could adversely affect our business and operating results.
Any transactions, combinations, acquisitions, dispositions or alliances may also require us to issue additional equity securities, spend our cash, or incur debt (and increased interest expense), liabilities, and amortization expenses related to intangible assets or write-offs of goodwill, which could adversely affect our results of operations and dilute the economic and voting rights of our stockholders and the interests of holders of our indebtedness.
In addition, we cannot assure you that any future acquisition of new businesses or technology will lead to the successful development of new or enhanced products and services or that any new or enhanced products and services, if developed, will achieve market acceptance or prove to be profitable. Further, we may also choose to divest certain businesses or product lines that no longer fit with our strategic objectives. If we decide to sell assets or a business, we may have difficulty obtaining terms acceptable to us in a timely manner, or at all. Additionally, the terms of such potential transactions may expose the Company to ongoing obligations and liabilities.
Our ability to use our deferred tax assets to offset future taxable income may be subject to certain limitations that could subject our business to higher tax liabilities.
We may be limited in the portion of net operating loss carryforwards that we can use in the future to offset taxable income for U.S. federal and state income tax purposes. The Tax Cuts and Jobs Act (the Tax Act) enacted on December 22, 2017, makes broad and complex changes to the U.S. tax code. While future interpretative guidance of
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the Tax Act and how many U.S. states will incorporate these federal law changes may have an impact on our business, the Tax Act’s reduction of the federal corporate income tax rate from 35% to 21%, effective January 1, 2018, has reduced our deferred tax asset associated with net operating loss carryforwards (NOLs). A lack of future taxable income would adversely affect our ability to utilize our NOLs.
In addition, under Section 382 of the Internal Revenue Code of 1986, as amended (Code), a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. Future changes in our stock ownership as well as other changes that may be outside of our control, could result in additional ownership changes under Section 382 of the Code. Our NOLs may also be impaired under similar provisions of state law.
We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. On the basis of this evaluation, a full valuation allowance has historically been recorded to recognize only deferred tax assets that are more likely than not to be realized.
Finally, further changes to the federal or state tax laws or technical guidance relating to the Tax Act that would further reduce the corporate tax rate could operate to effectively reduce or eliminate the value of any deferred tax asset. Our tax attributes as of December 31, 2019 may expire unutilized or underutilized, which could prevent us from offsetting future taxable income.
Our business may be adversely affected if our risk management framework does not effectively identify, assess and mitigate risk.
Our risk management framework seeks to appropriately balance risk and return and mitigate our risks. We have established policies intended to regularly identify and assess our risk profile, including credit risk, pricing risk, liquidity risk, strategic risk and operational risk, and then implement appropriate processes and controls to mitigate the risk.
If our risk management framework does not effectively identify, assess and/or mitigate our risk profile, we could suffer unexpected losses or be adversely affected, which could have a material adverse effect on our business. For example, assessment of our risk profile depends, in part, upon the use of forecasting models. If these models are ineffective at predicting future losses or are otherwise inadequate, we may incur unexpected losses or otherwise be adversely affected. In addition, the information we use may be inaccurate or incomplete, both of which may be difficult to detect and avoid. Additionally, there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated.
Failure to maintain, protect and promote our brand may harm our business.
Maintaining, protecting and promoting our brand is critical to achieving widespread acceptance of our products and services and expanding our base of borrowers and investors. Maintaining, protecting and promoting our brand depends on many factors, including our ability to continue to provide useful, reliable, secure and innovative products and services, as well as our ability to maintain trust.
Our brand can be harmed in many ways, including failure by us or our partners to satisfy expectations of service and quality, inadequate protection of sensitive information, failure to maintain or provide adequate or accurate documentation and/or disclosures, compliance failures, failure to comply with contractual obligations, regulatory requests, inquiries or proceedings, litigation and other claims, employee misconduct and misconduct by our partners. We have also been, and may in the future be, the target of incomplete, inaccurate and/or misleading statements about our company, our business, and/or our products and services. Furthermore, our ability to maintain, protect and promote our brand is partially dependent on visibility and customer reviews on third-party platforms. Changes in the way these platforms operate could make the maintenance, protection and promotion of our products and services and our brand more expensive or more difficult. If we do not successfully maintain, protect and
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promote our brand we may be unable to maintain and/or expand our base of borrowers and investors, which may materially harm our business.
Third party service disruptions may prevent us from being able to score and decision loan applicants, which may adversely affect our business.
The credit decisioning and scoring models we utilize are based on algorithms that evaluate a number of factors and currently depend on sourcing certain information from third parties, including consumer reporting agencies such as TransUnion, Experian or Equifax. In the event that any third party from which we source information experiences a service disruption, whether as a result of maintenance, error, natural disasters, terrorism or security breaches, whether accidental or willful, our ability to score and decision loan applications may be adversely impacted. This may result in us being unable to approve otherwise qualified applicants, which may adversely impact our business by negatively impacting our reputation and reducing the number of loans we are able to facilitate.
Negative publicity and unfavorable media coverage could negatively affect our business.
Negative publicity about our industry or our company, including with respect to the quality and reliability of our lending marketplace, effectiveness of the credit decisioning or scoring models used in the lending marketplace, the effectiveness of our collection efforts, statements regarding investment returns, changes to our lending marketplace, our ability to grow our borrower and investor base at a rate expected by the market, our ability to effectively manage and resolve borrower and investor complaints, our ability to manage borrower and investor accounts in compliance with regulatory requirements which may not be clear, privacy and security practices, use of loan proceeds by certain borrowers of ours or other companies in our industry for illegal purposes, litigation, regulatory activity and the experience of borrowers and investors with our lending marketplace or services, even if inaccurate, could adversely affect our reputation and the confidence in, and the use of, our lending marketplace, which could harm our business and operating results. Harm to our reputation can arise from many sources, including employee misconduct, misconduct by our partners or partners of partners, other online lending marketplaces, outsourced service providers or other counterparties, failure by us or our partners to meet minimum standards of service and quality, inadequate protection of borrower and investor information and compliance failures and claims.
The collection, processing, storage, use and disclosure of personal data could give rise to liabilities as a result of governmental regulation, conflicting legal requirements or differing views of personal privacy rights.
We receive, transmit and store a large volume of personally identifiable information and other user data. There are federal, state and foreign laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data. Specifically, personally identifiable information is increasingly subject to legislation and regulations in numerous U.S. and international jurisdictions, the intent of which is to protect the privacy of personal information that is collected, processed and transmitted in or from the governing jurisdiction. Governments, regulators, the plaintiffs’ bar, privacy advocates and customers have increased their focus on how companies collect, process, use , store, share and transmit personal data. This regulatory framework for privacy issues worldwide is evolving and is likely to continue doing so for the foreseeable future, which creates uncertainty. For example, the California Consumer Privacy Act (CCPA) of 2018, which became effective January 1, 2020, imposes more stringent requirements with respect to California data privacy. The CCPA will, among other things, give California residents expnaded rights to access and delete certain personal information, opt out of certain personal information sharing, and receive detailed information about how certain personal information is used. Additionally, the California Department of Justice published draft regulations to implement the CCPA. We cannot yet predict the full impact of the CCPA on our business or operations, but it may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. We could also be adversely affected if other legislation or regulations are expanded to require changes in business practices or privacy policies, or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, financial condition and results of operations. Any actual or perceived failure to comply with data privacy laws or regulations, or related contractual or other obligations, or any perceived privacy rights violation, could lead to investigations, claims, and proceedings by governmental entities and private parties,
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damages for contract breach, and other significant costs, penalties, and other liabilities, as well as harm to our reputation and market position.
We post on our website our privacy policies and practices concerning the collection, use, and disclosure of information. We also obtain consent from our borrowers to share information under certain conditions. Our failure, real or perceived, to comply with applicable privacy policies or federal, state or foreign laws and regulations or any compromise of security that results in the unauthorized release of personally identifiable information or other user data could damage our reputation, discourage potential borrowers or investors from using our lending marketplace or result in fines or proceedings brought against us, our issuing banks or other third parties by governmental agencies, borrowers, investors or other third parties, one or all of which could adversely affect our business, financial condition and results of operations. In addition to laws, regulations and other applicable common law rules regarding privacy and privacy advocacy, industry groups or other private parties may propose new and different privacy standards. We could also be subject to liability for the inappropriate use of information made available by us. Because the interpretation and application of privacy and data protection laws and privacy standards are still uncertain, it is possible that these laws or privacy standards may be interpreted and applied in a manner that is inconsistent with our practices. Any inability to adequately address privacy concerns, even if unfounded, or to comply with applicable privacy or data protection laws, regulations and privacy standards, could result in additional cost and liability for us, damage our reputation, inhibit use of our lending marketplace and harm our business.
Any failure to protect our own intellectual property rights could impair our brand, or subject us to claims for alleged infringement by third parties, which could harm our business.
We rely on a combination of copyright, trade secret, trademark and other rights, as well as confidentiality procedures and contractual provisions to protect our proprietary technology, underwriting and credit decisioning credit data, processes and other intellectual property. However, the steps we take to protect our intellectual property rights may be inadequate. Third parties may seek to challenge, invalidate or circumvent our copyright, trade secret, trademark and other rights or applications for any of the foregoing. Further, as our business continues to expand we may increase our dependence on third parties to provide additional products and services. Third parties who are contractually obligated to protect our intellectual property may be the target of data breaches or may breach their obligations and disseminate, misappropriate or otherwise misuse our proprietary technology, underwriting and credit decisioning credit data, processes and other intellectual property. Additionally, our competitors, as well as a number of other entities and individuals, may own or claim to own intellectual property relating to our industry. From time to time, third parties may claim that we are infringing on their intellectual property rights, and we may be found to be infringing on such rights. We may, however, be unaware of the intellectual property rights that others may claim cover some or all of our technology or services.
In order to protect our intellectual property rights, we may be required to spend significant resources. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management and could result in the impairment or loss of portions of our intellectual property. In addition, any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from offering our products or operating our platform or require that we comply with other unfavorable terms. Our failure to secure, protect and enforce our intellectual property rights could seriously adversely affect our brand and adversely impact our business.
Risk retention rules may increase our compliance costs, impair our liquidity and otherwise adversely affect our operating results.
We have been using, and may increasingly use, securitizations and other structured program transactions, like our CLUB Certificates, as a source of liquidity and financing for our business. Such transactions provide us with additional sources of investor demand for the consumer loans facilitated through our platform. If credit rating downgrades, market volatility, market disruptions, regulatory requirements or other factors impede our ability to
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complete additional structured program transactions on a timely basis or upon terms acceptable to us, our ability to fund our business may be adversely affected.
Effective as of December 24, 2016, “risk retention” rules promulgated by U.S. federal regulators under the Dodd-Frank Act (the U.S. Risk Retention Rules) require a “securitizer” or “sponsor” of a securitization transaction to retain, directly or through a “majority-owned affiliate” (each as defined in the U.S. Risk Retention Rules), in one or more prescribed forms, at least 5% of the credit risk of the securitized assets. For the securitization transactions for which we have acted as “sponsor,” we have sought to satisfy the U.S. Risk Retention Rules by retaining a “vertical interest” (as defined in the U.S. Risk Retention Rules) through either a majority-owned affiliate (MOA) or directly on our balance sheet. For any CLUB Certificate transactions, we have sought to satisfy the U.S. Risk Retention Rules by retaining a 5% interest in the CLUB Certificate issued by the applicable series trust. In addition to the discussion in this section, see “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 1. Basis of Presentation” and “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 7. Securitizations and Variable Interest Entities.” In addition, in order to facilitate certain investor offerings in Europe, we structured certain of the securitization transactions for which we acted as “sponsor” prior to January 1, 2019 so they complied with the risk retention and ongoing monitoring and diligence requirements of (i) Articles 404-410 of the European Capital Requirements Regulation, as supplemented by the Commission Delegated Regulation (EU) No. 625/2014 and Commission Implementing Regulation (EU) No. 602/2014 (the CRR Requirements), (ii) Article 17 of the European Union Alternative Investment Fund Managers Directive and Articles 50-56 of the Alternative Investment Fund Managers Regulation (EU) No. 231/2013 (the AIFM Requirements), and (iii) Article 135(2) of EU Directive 2009/138/EC, as supplemented by Articles 254-257 of the Commission Delegated Regulation (EU) No. 2015/35 (the Solvency II Requirements, together with the CRR Requirements and the Solvency II Requirements, the Old EU Risk Retention Rules). We have sought to satisfy the Old EU Risk Retention Rules with respect to such securitization transactions by retaining a “material net economic interest” (as defined in the Old EU Risk Retention Rules) directly on our balance sheet.
The Old EU Risk Retention Rules were replaced by new requirements that are applicable to securitizations in respect of which the relevant securities were issued on or after January 1, 2019. For securitizations in respect of which the relevant securities were issued before January 1, 2019, the Old EU Risk Retention Rules continue to apply. The new requirements were adopted by the European Parliament and the Council of the European Union as Regulation (EU) 2017/2402 of December 12, 2017 (the New EU Risk Retention Rules, together with the Old EU Risk Retention Rules and the U.S. Risk Retention Rules, the Risk Retention Rules). There can be no assurance that our securitizations issued after January 1, 2019 will fully comply with the New EU Risk Retention Rules or new EU due diligence and transparency requirements which may have a negative effect on our ability to complete additional securitization transactions.
We have also participated in other securitizations for which we have determined that we are not the “sponsor,” and accordingly, we have not sought to comply with any Risk Retention Rules that would be applicable to the “sponsor” of those transactions. The Risk Retention Rules are subject to varying interpretations, and one or more regulatory or governmental authorities could take positions with respect to the Risk Retention Rules that conflict with, or are inconsistent with, the Risk Retention Rules as understood or interpreted by us, the securitization industry generally, or past or current regulatory or governmental authorities. There can be no assurance that applicable regulatory or governmental authorities will agree with any of our determinations described above, and if such authorities disagree with such determinations, we may be exposed to additional costs and expenses, in addition to potential liability. Furthermore, we expect that compliance with the Risk Retention Rules (and other related laws and regulations), as currently understood by us, may entail the implementation of new forms, processes, procedures, controls and infrastructure. Such implementation may be costly and may adversely affect our operating results.
In addition to the increased costs we expect to be generated by our efforts to comply with applicable Risk Retention Rules, which may be significant, we expect compliance with any applicable Risk Retention Rules will tie up our capital, which could potentially have been deployed in other ways that could have generated better value for our shareholders. Holding risk retention interests or loans in contemplation of structured financing increases our
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exposure to the performance of the loans that underlie or are expected to underlie those transactions. Accordingly, although compliance with applicable Risk Retention Rules would be expected to more closely align our incentives with those of the investors in our loans, it is also expected that poor loan performance may have a heightened adverse effect on the value of our shares. This may exacerbate the negative effects of poor loan performance on the value of our shares.
If we breach representations or warranties that we made in our securitization, whole loan or CLUB Certificate transactions, or if either we suffer a direct or indirect loss in our retained interests in these transactions, our financial condition could be harmed.
We sponsor a number of sales of unsecured personal whole loans through asset-backed securitizations. In connection with these securitizations, as well as our whole loan and CLUB Certificate transactions, we make certain customary representations, warranties and covenants. If there is a breach of those representations and warranties that materially and adversely affects the value of the subject loans, then we will be required to either cure the breach, repurchase the affected loans from the purchasing entity, replace the affected loans with other loans or make a loss of value payment, as the case may be. Any losses that result could be material and have an adverse effect on our financial condition.
For a description of the interests we have retained in connection with complying with risk retention rules applicable to us as a sponsor of securitization transactions, see “Risk retention rules may increase our compliance costs, impair our liquidity and otherwise adversely affect our operating results.” In the event that we suffer losses on all or a portion of the interests in any securitization transaction that we have retained (whether to comply with applicable risk retention rules or otherwise), our financial condition could be harmed.
We may enter into similar transactions in the future and those transactions are likely to entail similar and other substantial risks.
If we are unable to offer investors a satisfactory breadth and volume of investment opportunities, our business and results of operations may be materially harmed.
We invest in our lending marketplace platform and regularly iterate our processes to provide improved and more efficient investment opportunities, which includes efforts to provide investors the opportunity to invest in a broad selection of loans. However, various factors may contribute to certain loans being available only in a limited quantity or being entirely unavailable to certain investors.
With respect to our member payment dependent notes, our lending marketplace platform allows investors to select which loans to invest in manually, via an application program interface (API) or by using our automated investing service which selects notes based on investment criteria selected by the investor. Loans selected for investment by a particular investor or group of investors may not be available for investment to other investors. This variability in the availability of loans for investment may cause returns to vary from investor to investor. For example, certain loans selected via API or by manual investors may be unavailable when the automated investing service orders are placed and therefore returns of manual investors or investors utilizing API may vary from, and be higher than, the returns from our automated investing service if manual investors or investors utilizing API are able to identify and select higher performing loans.
In addition, some of our agreements with platform investors contain provisions regarding the manner in which our lending marketplace platform product operates that could constrain the manner in which our lending marketplace platform product can develop, particularly with respect to how loans are selected for investment. Some of these agreements provide for significant damages in the event of a breach and some provide for liquidated damages in the event that we are unable to perform and deliver in accordance with the contractual specifications and schedule. These agreements could constrain the development of our lending marketplace, including efforts to offer a breadth of investment opportunities for and among a variety of investors, and/or result in significant damages that could impact our results in a given period.
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If investors, automated or otherwise, are unable to invest in certain categories of loans, are unable to invest at the volume they desire, perceive that they are not offered the same investment opportunities as other investors and/or are dissatisfied with the risk-adjusted return they receive from investing on our platform, they may seek alternative investments from ours which may materially harm our business and results of operations.
If we fail to attract and retain our highly skilled employees needed to support our business, we may not be able to achieve our anticipated level of growth and our business could suffer.
We believe our success depends on the efforts and talents of our employees, including software engineers, financial, credit and risk personnel and marketing professionals. Our future success depends on our continued ability to attract, develop, motivate and retain highly qualified and skilled employees. Competition for highly skilled technical and financial personnel, particularly in the San Francisco Bay Area, is extremely intense. Building and maintaining a positive culture and work environment that reinforces the Company’s values is also critical to attracting and retaining employees.
We have had a high attrition rate from employees and expect our attrition rate to remain elevated. We may not be able to hire and retain these personnel at compensation levels consistent with our existing compensation and salary structure. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment. Additionally, changes in U.S. immigration policy may make it difficult to renew or obtain visas for certain highly skilled employees that we have hired or are recruiting.
In addition to attracting and retaining highly skilled employees in general, our future performance depends, in part, on our ability to attract and retain key personnel, including our executive officers, senior management team and other key personnel, all of whom would be difficult to replace. The loss of the services of our executive officers or members of our senior management team, and the process to replace any of them, would involve significant time and expense and distraction that may significantly delay or prevent the achievement of our business objectives or impair our operations or results.
If we were required to register as a broker-dealer under federal or state law, our costs could significantly increase or our operations could be impaired.
We issue securities and, in certain instances, offer them directly to investors. We are not registered as a broker-dealer with the SEC nor do we operate as a registered broker-dealer in any jurisdiction. This limits the methods and manners by which we may market and sell our securities. If a regulatory body were to find that our activities require us to register as a broker-dealer or to market and sell our securities only through a registered broker-dealer, we may have to constrain our current business activities and we could be subject to fines, rescission offers or other penalties, and our compliance costs and other costs of operation could increase significantly, all of which could materially adversely affect our business and results of operations.
We have incurred net losses in the past and may incur net losses in the future.
As of December 31, 2019, our accumulated deficit was $548.5 million. Our operating expenses may continue to be elevated as we resolve additional matters that arose from legacy management (including indemnification legal expenses paid by the Company for former employees), settle regulatory investigations and examinations, enhance our compliance systems, reestablish the growth of our business, attract borrowers, investors and partners, and further enhance and develop our products, lending marketplace and platform. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently to offset these higher expenses. We may incur additional net losses in the future and may not maintain profitability on a quarterly or annual basis.
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We may have to constrain our business activities to avoid being deemed an investment company under the Investment Company Act of 1940.
In general, a company that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities may be deemed to be an investment company under the Investment Company Act of 1940, as amended (Investment Company Act). The Investment Company Act contains substantive legal requirements that regulate the manner in which “investment companies” are permitted to conduct their business activities. We believe we have conducted, and we intend to continue to conduct, our business in a manner that does not result in our company being characterized as an investment company. To avoid being deemed an investment company, we may decide not to broaden our offerings, which could require us to forego attractive opportunities. We may also apply for formal exemptive relief to provide additional clarity on our status under the Investment Company Act. We may not receive such relief on a timely basis, if at all, and such relief may require us to modify or curtail our operations. If we are deemed to be an investment company under the Investment Company Act, we may be required to institute additional compliance requirements and our activities may be restricted, which could materially adversely affect our business, financial condition and results of operations.
Our business operations may be adversely impacted by political events, terrorism, public health issues, natural disasters, labor disputes and other business interruptions.
Our business operations are subject to interruption by, among other things, political events, terrorism, public health issues, natural disasters, labor disputes and other events which could decrease demand for our products and services or make it difficult or impossible for us to deliver a satisfactory experience to our borrowers and investors, any of which may have a material adverse impact on our business, financial condition and results of operations. For example, a federal government shutdown could impair our ability to support our structured program initiatives and/or resolve outstanding litigation or regulatory inquiries with the federal government.
Furthermore, in the event of any disruption to our operations or those of the companies with whom we do business with, we could incur significant losses, require substantial recovery time and experience significant expenditures in order to resume or maintain operations, any of which could have a material adverse impact on our business, financial condition and results of operations.
Misconduct and errors by our employees and third-party service providers could harm our business and reputation.
We are exposed to many types of operational risk, including the risk of misconduct and errors by our employees and other third-party service providers. Our business depends on our employees and third-party service providers to facilitate the operation of our business and process a large number of increasingly complex transactions, and if any of our employees or third-party service providers provide unsatisfactory service or take, convert or misuse funds, documents or data or fail to follow protocol when interacting with borrowers and investors, we could lose customers, harm our reputation, be liable for damages, be subject to repurchase obligations and be subject to complaints, regulatory actions and penalties.
While we have internal procedures and oversight functions to protect the Company against this risk, we could also be perceived to have facilitated or participated in the illegal misappropriation of funds, documents or data, or the failure to follow protocol, and therefore be subject to civil or criminal liability.
Any of these occurrences could result in our diminished ability to operate our business, potential liability to borrowers and investors, inability to attract future borrowers and investors, reputational damage, regulatory intervention and financial harm, which could negatively impact our business, financial condition and results of operations.
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Some aspects of our platform include open source software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.
Aspects of our platform include software covered by open source licenses, which may include, by way of example, GNU General Public License and the Apache License. Open source license terms are often ambiguous, and there is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses. Therefore, the potential impact of such terms on our business is somewhat unknown. If portions of our proprietary software are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our technologies or otherwise be limited in the licensing of our technologies, each of which could reduce or eliminate the value of our technologies and products. There can be no assurance that efforts we take to monitor the use of open source software to avoid uses in a manner that would require us to disclose or grant licenses under our proprietary source code will be successful, and such use could inadvertently occur. This could harm our intellectual property position and have a material adverse effect on our business, results of operations, cash flow, and financial condition. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. Many of the risks associated with use of open source software cannot be eliminated, and could adversely affect our business.
Our platform and internal systems rely on software that is highly technical, and if it contains undetected errors, our business could be adversely affected.
Our platform and internal systems rely on software that is highly technical and complex. In addition, our platform and internal systems depend on the ability of such software to store, retrieve, process and manage immense amounts of data. The software on which we rely has contained, and may now or in the future contain, undetected errors or bugs. Some errors may only be discovered after the code has been released for external or internal use. Errors or other design defects within the software on which we rely may result in a negative experience for borrowers and investors, delay introductions of new features or enhancements, result in errors or compromise our ability to protect borrower or investor data or our intellectual property. Any errors, bugs or defects discovered in the software on which we rely could result in harm to our reputation, loss of borrowers or investors, loss of revenue or liability for damages, any of which could adversely affect our business and financial results.
If one or more of our counterparty financial institutions default on their financial or performance obligations to us or fail, we may incur significant losses.
We have significant amounts of cash and cash equivalents in accounts with banks or other financial institutions. Certain banks and financial institutions are also lenders under our credit facilities. We regularly monitor our exposure to counterparty credit risk, and actively manage this exposure to mitigate the associated risk. Despite these efforts, we may be exposed to the risk of default by, or deteriorating operating results or financial condition or failure of, these counterparty financial institutions. The risk of counterparty default, deterioration, or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to access or recover assets that are deposited, held in accounts with, or otherwise due from, such counterparty may be limited by the counterparty’s liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default or failure of one or more of our counterparties, we may be unable to operate our business in the ordinary course, which would materially adversely impact our results of operations and financial condition.
Investors in CLUB Certificates offered by the Company may be deemed to have been solicited by general solicitation or general advertising, and such investors could seek to rescind their purchase.
We offer member payment dependent notes publicly pursuant to the Note Registration Statement. In addition, the Company sells CLUB Certificates. Sales of CLUB Certificates are made through private transactions with investors and are separate from the public offering of the member payment dependent notes. Because of the fact-specific
LENDINGCLUB CORPORATION
nature of what types of activities might constitute a general solicitation or general advertising, it is possible that some of the CLUB Certificate investors could assert that they became interested in an investment in CLUB Certificates through a general solicitation or general advertising with regard to CLUB Certificates or through the public offering of member payment dependent notes. If it was determined that an investor’s interest in the CLUB Certificates was the result of a general solicitation or general advertisement, the investor could claim that the sale of CLUB Certificates violated Section 5 of the Securities Act and could seek to rescind their purchase or seek other remedies, subject to any applicable statute of limitations. We would contest vigorously any claim that a violation of the Securities Act occurred, however, litigation is inherently uncertain and can be expensive and time consuming.
We have not reviewed our compliance with foreign laws regarding the participation of non-U.S. residents on our lending marketplace.
From time to time, non-U.S. residents invest in loans directly through our lending marketplace. We are not experts with respect to all applicable laws in the various foreign jurisdictions from which an investor may be located, and we cannot be sure that we are complying with applicable foreign laws. Failure to comply with such laws could result in fines and penalties payable by us, which could reduce our profitability or cause us to modify or delay planned expansions and expenditures, including investments in our growth. In addition, any such fines and penalties could create negative publicity, result in additional regulatory oversight that could limit our operations and ability to succeed, or otherwise hinder our plans to expand our business internationally.
Our credit facilities provide our lenders with first-priority liens against substantially all of our assets and contain certain affirmative and negative covenants and other restrictions on our actions, and could therefore limit our operational flexibility or otherwise adversely affect our financial condition.
We have certain credit facilities that contain restrictive covenants relating to our capital raising activities and other financial and operational matters. These restrictive covenants may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions or other strategic transactions. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be impaired, and our business may be harmed.
If we fail to perform under the loan agreements for these credit facilities by, for example, failing to make timely payments or failing to comply with the required total leverage ratio, our operations and financial condition could be adversely affected. For more information regarding the covenants and requirements, see “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 14. Debt” included in this Report.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
Our stock price has been and will likely continue to be volatile.
Our stock price has declined significantly since the end of the first quarter of 2016 and has exhibited substantial volatility. Our stock price may continue to fluctuate in response to a number of events and factors, such as quarterly operating results; changes in our financial projections provided to the public or our failure to meet those projections; changes in the credit performance on our platform; the public’s reaction to our press releases, other public announcements and filings with the SEC; progress and resolution with respect to existing litigation and regulatory inquiries; significant transactions, or new features, products or services by us or our competitors; changes in financial estimates and recommendations by securities analysts; media coverage of our business and financial performance; the operating and stock price performance of, or other developments involving, other companies that investors may deem comparable to us; trends in our industry; any significant change in our management; and general economic conditions.
LENDINGCLUB CORPORATION
In addition, the stock market in general, and the market prices for companies in our industry, have experienced volatility. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Price volatility over a given period may cause the average price at which we repurchase our own stock to exceed the stock’s price at a given point in time. Volatility in our stock price also impacts the value of our equity compensation, which affects our ability to recruit and retain employees. In addition, some companies that have experienced volatility in the market price of their stock, including us, have been subject to securities class action litigation. We have been the target of this type of litigation and may continue to be a target in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could harm our business.
If we fail to meet expectations related to future growth, profitability, or other market expectations, our stock price may decline significantly, which could have a material adverse impact on investor confidence and employee retention.
We are subject to ownership concentration by certain significant stockholders.
Ownership of our common stock is concentrated among certain stockholders. For example, per filings with the SEC, Shanda beneficially owns shares of our common stock representing approximately 22% of LendingClub Corporation’s voting power as of December 31, 2019.
Although we recently entered into an agreement whereby Shanda will exchange, subject to certain closing conditions, all shares of our common stock held by them for newly issued non-voting convertible preferred stock to enable the Company to pursue its bank charter initiative, any current or future stockholder or group of stockholders with a significant voting and/or economic concentration individually or in aggregate could determine to vote shares or otherwise exercise influence in a manner that may be contrary to the interests of the Company and/or other minority stockholders. For example, such stockholder(s) could sell shares in a manner that could affect our stock price or impede the Company from executing on an initiative for the benefit of all stockholders. In addition, the concentration of ownership may act as a deterrent to other potential investors purchasing our stock.
Future issuances and/or sales of common stock may result in significant dilution to our stockholders and may place downward pressure on our stock price.
We recently entered into an agreement whereby Shanda will exchange, subject to certain closing conditions, all shares of our common stock held by them for newly issued non-voting convertible preferred stock to enable the Company to pursue its bank charter initiative. In connection with the exchange, the Company will provide Shanda registration rights and a one-time cash payment. Under a registration rights agreement Shanda is entitled to certain registration rights with respect to Company securities held by it, which may facilitate their ability to sell their holdings. The market price of our common stock could decline as a result of sales by our existing stockholders in the market, or the perception that these sales could occur.
Further, we may issue additional equity securities to raise capital, support acquisitions, or for a variety of other purposes. We also utilize equity-based compensation as an important tool in recruiting and retaining employees and other service providers. Additional issuances of our stock may be made pursuant to the exercise or vesting of new or existing stock options or restricted stock units, respectively. Dilution to existing holders of our common stock from equity-based compensation and other additional issuances could be substantial and may place downward pressure on our stock price.
Our quarterly results may fluctuate significantly and may not fully reflect the longer term underlying performance of our business.
Our operating and financial results have varied on a quarterly basis during our operating history and may continue to fluctuate significantly. These fluctuations may be due to a variety of factors, some of which are outside of our control and may not fully reflect the underlying performance of our business. Factors that may cause fluctuations in
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our quarterly financial results include our ability to attract and retain new customers, seasonality in our business, the costs associated with and outcomes of legal and regulatory matters, volatility related to fraud and credit performance, the timing of capital markets transactions, variability in the valuation of loans held on our balance sheet, changes in business or macroeconomic conditions and variety of other factors, including as a result of the risks set forth in this “Risk Factors” section. Fluctuation in quarterly results and how we perform relative to guidance may adversely affect the price of our common stock.
If we were to become subject to a bankruptcy or similar proceeding, the right of payment of investors in our member payment dependent notes may be senior to the right of payment of our stockholders and there may not be value recoverable by our stockholders.
Under the terms of the member payment dependent notes offered through our lending marketplace, we are obligated to pay principal and interest on each member payment dependent note on a non-recourse basis only if and to the extent that we receive principal, interest or late fee payments from the borrower on the corresponding loan, but the member payment dependent notes become fully recourse to us if we fail to pay such obligation, which would include being prohibited from making such payments as a result of a bankruptcy or similar proceeding, or if we breach a covenant under the indenture governing the member payment dependent notes. In a bankruptcy or similar proceeding due to a default under current or future indebtedness, an action for repurchase or rescission of securities or other event, there is uncertainty regarding whether a holder of a member payment dependent note has any right of payment from our assets other than the corresponding loan. It is possible that a member payment dependent note holder could be deemed to have a right of payment from both the corresponding loan and from some or all of our other assets, in which case the member payment dependent note holder would have a claim to the proceeds of our assets that is senior to any right of payment of the holders of our common stock, regardless of whether we have received any payments from the underlying borrower, making it highly unlikely that there would be any value recoverable by our stockholders.
We recently entered into an agreement whereby Shanda will exchange, subject to certain closing conditions, all shares of our common stock held by them for newly issued non-voting convertible preferred stock to enable the Company to pursue its bank charter initiative. In connection with the exchange, the Company will provide Shanda registration rights and a one-time cash payment. Under a registration rights agreement Shanda is entitled to certain registration rights with respect Company securities held by it, which may facilitate their ability to sell their holdings. Additional shares of our common stock trading in the public market, as a result of the exercise of such registration rights, may have an adverse effect on the market price of our securities.
Anti-takeover provisions in our charter documents and Delaware law may delay or prevent an acquisition of our company.
Our restated Certificate of Incorporation and restated Bylaws contain provisions that can have the effect of delaying or preventing a change in control of us or changes in our management. The provisions, among other things:
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establish a classified board of directors so that not all members of our board of directors are elected at one time;
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permit only our board of directors to establish the number of directors and fill vacancies on the board;
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provide that directors may only be removed “for cause” and only with the approval of two-thirds of our stockholders;
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require two-thirds vote to amend some provisions in our restated Certificate of Incorporation and restated Bylaws;
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authorize the issuance of “blank check” preferred stock that our board of directors could use to implement a stockholder rights plan (also known as a “poison pill”);
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eliminate the ability of our stockholders to call special meetings of stockholders;
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prohibit stockholder action by written consent, which will require that all stockholder actions must be taken at a stockholder meeting;
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do not provide for cumulative voting; and
LENDINGCLUB CORPORATION
•
establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at annual stockholder meetings.
In connection with the Company’s bank charter initiative, we have adopted a Charter Protection Agreement which is designed to deter ownership positions in the Company’s stock in excess of certain thresholds set forth by the Federal Reserve under the Bank Holding Company Act by diluting any stockholder who amasses an ownership position in excess of such thresholds without the Company’s approval. To ensure the arrangement is tailored to protect the Company and not unduly infringe on the rights of stockholders, the rights distributed pursuant to the Charter Protection Agreement shall automatically be redeemed upon the earlier of 18 months or the close of the Transaction. Nonetheless, the Charter Protection Agreement may deter certain stockholders from purchasing shares of the Company’s common stock, which may suppress demand for the stock and cause the price to decline.
These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or changes in our management.
If securities or industry analysts do not publish research or reports about our business, or publish inaccurate or unfavorable research reports about our business, our stock price and trading volume could decline.
Research and reports that securities or industry analysts publish about us or our business may be consumed by equity investors and influence their opinion of our business and/or investment in our common stock. For example, if one or more of the analysts who cover us downgrades our stock, our stock price may decline. Additionally, if one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.
We do not intend to pay dividends for the foreseeable future.
We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, an investor may only receive a return on their investment in our common stock if the trading price of our common stock increases.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The information set forth under “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 18. Leases” of this Form 10-K is incorporated herein by reference.
Item 3.
Item 3. Legal Proceedings
The information set forth under “Part II - Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 19. Commitments and Contingencies” of this Form 10-K is incorporated herein by reference.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
LENDINGCLUB CORPORATION
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information for Common Stock
LendingClub’s common stock is listed on the New York Stock Exchange (NYSE) under the ticker symbol “LC.”
Holders of Record
As of January 31, 2020, there were 36 holders of record of LendingClub’s common stock. Because many of LendingClub’s shares of common stock are held by brokers and other institutions on behalf of stockholders, the Company is unable to estimate the total number of stockholders represented by these record holders.
Dividend Policy
LendingClub has not paid cash or other dividends since its inception, and does not anticipate paying cash or other dividends in the foreseeable future.
Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
The table below summarizes purchases made by or on behalf of LendingClub of its common stock for each calendar month in the fourth quarter of 2019:
(1)
Represents shares that were transferred to the Company to satisfy payment of all or a portion of the exercise price in connection with the exercise of stock options, and not as part of a publicly announced plan or program.
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Performance Graph
This performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of LendingClub under the Securities Act of 1933, as amended, or the Exchange Act.
The following graph and table compare the cumulative total return to stockholders of LendingClub’s common stock relative to the cumulative total returns of the Standard & Poor’s 500 Index and the Dow Jones Internet Composite Index. An investment of $100 (with reinvestment of all dividends, when applicable) is assumed to have been made in LendingClub’s common stock and in each index at market close on December 31, 2014 and its relative performance is tracked through December 31, 2019. The returns shown are based on historical results and are not intended to suggest future performance.
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Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes that appear in this Annual Report on Form 10-K (Report). In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and in this Report, particularly in “Part I - Item 1A. Risk Factors.”
Overview
LendingClub was incorporated in Delaware on October 2, 2006, and is currently the largest provider of unsecured personal loans in the US. We operate America’s largest online lending marketplace platform that connects borrowers and investors. LendingClub provides tools that help Americans save money on their path to financial health through lower borrowing costs and a seamless, technology-driven user experience. Investors provide capital to enable the funding of loans in exchange for earning competitive risk adjusted returns. Our marketplace enables efficient credit decisioning, pricing, servicing and support operations. We operate fully online with no traditional branch infrastructure. Our vision is to expand our marketplace model and support it with a bank charter, which we believe will be both strategically and financially accretive to the Company.
We generate revenue primarily from transaction fees from our lending marketplace’s role in marketing to customers, accepting and decisioning applications for our bank partners to enable loan originations, investor fees that include servicing fees from investors for various services, including servicing and collection efforts, gains on sales of loans sold, net interest income and fair value adjustments from loans invested in by the Company and held on our balance sheet.
The transaction fees we receive from our issuing bank partner in connection with our lending marketplace’s role in facilitating loan originations for unsecured personal loans and auto refinance loans range from 0% to 6% of the initial principal amount of the loan. In addition, for education and patient finance loans, we collect fees from issuing banks and from the related education and patient service providers.
Net interest income and fair value adjustments reflect earned interest income and assumed principal and interest rate risk on loans during the period that we own the loans. When we use our own capital to invest in loans, we earn interest income and record fair value adjustments attributable to changes in actual and expected credit and prepayment performance, or any difference between sale price and carrying value.
Investor fees paid to us vary based on investment channel and compensate us for the costs we incur in servicing loans, including managing payments from borrowers, collections, payments to investors, maintaining investors’ account portfolios, providing information and issuing monthly statements. Investor fees may also vary based on the delinquency status of the loan. Whole loan purchasers pay a monthly weighted-average fee of 0.9% per annum and Structured Program investors pay a monthly fee of up to 1%, which is generally based on the month-end principal balance of loans serviced by us.
Gain (Loss) on sales of loans connected to loan sale transactions are recognized based on the level to which the contractual loan servicing fee is above or below an estimated market rate loan servicing fee. Additionally, we recognize transactions costs as a loss on sale of loans.
Personal loan volume on our platform is generally lower in the first quarter of the year, primarily due to seasonality of borrower behavior. Additionally, in the fourth quarter of the year, we typically observe fluctuations in marketing
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
effectiveness and borrower behavior due to the holidays, which can impact volume. These seasonal trends contribute to fluctuations in our operating results and operating cash flow.
Loans facilitated through our lending marketplace are funded by the sale of whole loans to banks and other institutional investors, the sale of whole loans facilitated through Structured Programs, the issuance of notes to our self-directed retail investors, or funded directly by the Company with its own capital. We use our capital to fund the purchase of loans for our Structured Program transactions, to support marketplace equilibrium when a matching third-party investor is not available at time of origination, to reflect changes in market value through loan pricing, to test new product offerings, and to make accommodations to customers. The Company’s Structured Program transactions include i) asset-backed securitization transactions and ii) Certificate Program transactions. Certificate Program transactions include CLUB Certificate and Levered Certificate transactions.
In connection with asset-backed securitizations, the Company is the sponsor and establishes trusts to ultimately purchase the loans from the Company and/or third-party whole loan investors. Securities issued from our asset-backed securitizations are senior or subordinated based on the waterfall criteria of loan payments to each security class. The subordinated residual interests issued from these transactions are first to absorb credit losses in accordance with the waterfall criteria. The loans are transferred into a trust such that the loans are legally isolated from the creditors of the Company and are not available to satisfy obligations of the Company. These loans can only be used to settle obligations of the underlying trusts. As the sponsor for securitization transactions, the Company manages the completion of the transaction.
In addition, the Company sponsors the sale of loans through the issuance of certificate securities under our Certificate Program. The Certificate securities are collateralized by loans transferred to a series of a master trust and trade in the over-the-counter market with a CUSIP. We believe the sale of certificates results in more liquidity and demand for our unsecured personal loans. The loans are transferred into a trust such that the loans are legally isolated from the creditors of the Company and are not available to satisfy the obligations of the Company. These loans can only be used to settle obligations of the underlying Certificate Program trusts. The CLUB Certificate issued securities are pass-through securities of which each owner has an undivided and equal interest in the underlying loans of each transaction. The Levered Certificate issued securities includes senior and subordinated securities based on the waterfall criteria of loan payments to each security class. The subordinated securities issued from these transactions are first to absorb credit losses in accordance with the waterfall criteria.
Current Economic and Business Environment
Our online lending marketplace platform seeks to adapt to changing marketplace conditions and investors’ return on investment expectations. LendingClub monitors a variety of economic, credit and competitive indicators to propose changes to issuing banks’ credit policies and interest rates.
In the fourth quarter of 2019, our marketplace facilitated $3.1 billion of loan originations, of which $1.2 billion was issued through whole loan sales, $1.7 billion was purchased or pending purchase by the Company and $0.1 billion was issued through member payment dependent notes. Loans held by the Company at quarter end are available loan inventory for future Structured Program transactions and whole loan sales, excluding loans held by the Company as a result of consolidated trusts.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table shows the loan origination volume issued, loans purchased or pending purchase by the Company, and the available loan inventory as of the end of each period set forth below (in millions):
(1)
LendingClub inventory reflects loans purchased or pending purchase by the Company during the period, excluding loans held by the Company through consolidated trusts, if applicable, and not yet sold as of the period end.
Loan inventory purchased by LendingClub was 23% of total loan originations during the fourth quarter of 2019. This increase since the second quarter of 2019 was due to higher volumes and mix of lower risk grade A and B loans facilitated on our marketplace, the volume of loans purchased by LendingClub for Structured Program transactions, and the timing of loan sales compared to prior periods.
As market interest rates fluctuate, our investors’ cost of funding and expectations regarding return on investment changes. We have continued to take actions to reduce exposure to certain borrower segments that have had insufficient risk-adjusted returns, especially in lower loan grades and certain FICO bands where losses have historically been more volatile. We have seen a volume and mix increase of grade A and B loans in our standard loan program. As prevailing interest rates and market conditions change, we will continue to adjust interest rates and credit criteria on the platform accordingly. Separately, we periodically adjust products available on our marketplace to reflect investor demand.
Because of timing differences between changes in market interest rates, interest rates on loans, credit performance and investor yield expectations, there may be a difference between the actual yield and the investor required yield on a loan. In these circumstances we continue to use our own capital to purchase loans from our issuing banks. This allows us to adjust the effective yield on a loan through its sale price, thereby maintaining marketplace equilibrium. Any discount to par will result in negative fair value adjustments.
In 2019, we reviewed our cost structure and have a number of expense initiatives underway with the goal of increasing our operating efficiency. As a result of our review, we signed a lease to establish a site in a more cost-effective location in the Salt Lake City area. We started to hire full-time employees in the first quarter of 2019 in the Salt Lake City area and we have increased the use of third-party business process outsource providers. We completed the relocation of our origination and servicing operations from San Francisco, California to the Salt Lake City area by the end of 2019. In conjunction with this initiative, we have sublet some of our office space in San Francisco, California, and may sublet incremental office space in the future. Although historically we have internally developed our loan platform technology solutions, in an effort to reduce costs and improve the optimization of our engineering resources for higher value-add software development, we are increasing our usage of third-party technology for certain services. While we expect the implementation of these expense initiatives to increase expenses in the short-term, they are expected to result in overall increased operating efficiency for the Company.
On February 18, 2020, the Company and Radius Bancorp, Inc. (Radius) entered into an Agreement and Plan of Merger, by and among the Company, a wholly owned-subsidiary of the Company, and Radius, pursuant to which the Company will acquire Radius and thereby acquire its wholly-owned subsidiary, Radius Bank (the Merger), in a cash and stock transaction valued at $185 million (of which $138.75 million is in cash and $46.25 million is in
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
stock), plus certain purchase price and expense adjustments of up to $22 million. The closing of the Merger is subject to regulatory approval and other customary closing conditions, which the Company anticipates can be completed within 15 months, as well as customary transaction costs. The Company believes that acquiring Radius and operating with a national bank charter will enhance LendingClub’s ability to serve its members, grow its market opportunity, increase and diversify revenue and earnings, and provide both funding resilience and regulatory clarity. With the talent, infrastructure and capabilities Radius possesses, the Company intends to enhance customer engagement by offering a broader range of member products and services aimed at supporting members and improving their financial health. The Merger will be accounted for as a business combination. The purchase price will be allocated to the assets acquired and liabilities assumed based on their fair values at the acquisition date.
In order to facilitate compliance with federal banking regulations by the Company’s largest stockholder, Shanda Asset Management Holdings Limited and its affiliates (Shanda), on February 18, 2020, the Company entered into a Share Exchange Agreement pursuant to which Shanda will exchange, subject to certain closing conditions, all shares of the Company’s common stock held by Shanda for newly issued non-voting convertible preferred stock, series A (the Exchange). In connection with the Exchange, the Company will provide Shanda registration rights and a one-time cash payment of approximately $50 million. To deter future ownership positions in the Company’s securities in excess of thresholds set forth by the Federal Reserve under the Bank Holding Company Act, the Company adopted a Temporary Bank Charter Protection Agreement (the Charter Protection Agreement) which provides for the dilution of any person or group of persons that acquires: (i) 25% or more equity interest in the Company, or (ii) 7.5% or more of any class of the Company’s voting securities, which threshold shall automatically increase to 10% in connection with the closing of the Exchange. The Charter Protection Agreement is effective as of February 18, 2020, and will automatically expire on the earlier of the closing of the Merger or 18 months.
Factors That Can Affect Revenue
As an operator of a lending marketplace, we work to match the supply of loans facilitated through our platform and demand from investors while also growing the overall volume of originations and correspondingly revenue at a pace commensurate with proper planning, compliance, risk management, user experience, and operational controls that work to optimize the quality of the customer experience, customer satisfaction and long-term growth. In addition, we have been increasingly utilizing our balance sheet to support Structured Program transactions, manage marketplace equilibrium, hold loans for testing new or existing loan products and repurchase loans that did not meet an investor’s criteria. In most instances, we subsequently sell those loans, recognizing a gain or loss on their sale.
Loan supply, which is partly driven by borrower-related activities within our business, combined with investor demand to purchase loans on our platform as well as our own loan purchases, can affect our revenue in any particular period. These drivers collectively affect transaction fees, investor fees earned by us related to these transactions, interest income, fair value adjustments and other revenue related to loans held on balance sheet, including the performance of such loans. As these drivers can be affected by a variety of factors, both in and out of our control, revenues may fluctuate from period to period. Factors that can affect these drivers and ultimately revenue and its timing include:
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investor demand for our loans;
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loan performance and return on investment;
•
market confidence in our data, controls, and processes;
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announcements and terms of resolution of governmental inquiries or private litigation;
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our ability to obtain or add bank functionality and a bank charter;
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the impact on the business from obtaining or adding bank functionality and a bank charter;
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the mix of borrower products and corresponding transaction fees;
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regulatory or market factors which limit products on our platform or loan interest rates borrowers can pay;
•
availability or the timing of the deployment of investment capital by investors;
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
•
the availability and amount of new capital from pooled investment vehicles and managed accounts that typically deploy their capital at the start of a period;
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the amount of purchase limitations we can impose on larger investors as a way to maintain investor balance and fairness;
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the attractiveness of alternative opportunities for borrowers or investors, through changes in interest rates, transaction fees, terms, or risk profile;
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the responsiveness of applicants to our marketing efforts;
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expenditures on marketing initiatives in a period;
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the sufficiency of operational staff to process any manual portion of the loan applications in a timely manner;
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the responsiveness of borrowers to satisfy additional income or employment verification requirements related to their application;
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borrower withdrawal rates;
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the percentage distribution of loans between the whole and fractional loan platforms;
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platform system performance;
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seasonality in demand for our platform and services, which is generally lowest in the first quarter and also impacts the fourth quarter;
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determination to hold loans for purposes of subsequently distributing the loans through sale or Structured Program transactions;
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changes in the credit performance of loans or market interest rates;
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the success of our models to predict borrower risk levels and related investor demand; and
•
other factors.
At any point in time we have loan applications in various stages from initial application through issuance. Depending upon the timing and impact of the factors described above, loans may not be issued by the issuing banks who originate loans facilitated through our marketplace in the same period in which the corresponding application was originally made, resulting in a portion of that subsequent period’s revenue being earned from loan applications that were initiated in the immediately prior period. Consistent with our revenue recognition accounting policy under GAAP, we do not recognize the transaction fee revenue associated with a loan until the loan is issued by the issuing bank and the proceeds are delivered to the borrower. Our transaction fees are generally paid by the issuing bank (which collects an origination fee from the borrower), or in the case of education and patient finance loans, may also be paid by the medical or education service provider, and are accordingly independent of who is investing in a loan or how a loan is invested in.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Key Operating and Financial Metrics
We regularly review several metrics to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions. The following presents our key operating and financial metrics:
(1)
All share and per share information has been retroactively adjusted to reflect a reverse stock split. See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 4. Net Loss Per Share” for additional information.
(2)
Represents non-GAAP financial measures. For more information regarding these measures and a reconciliation of these measures to the most comparable GAAP measures, see “Non-GAAP Financial Measures” below.
Loan Originations
We believe the volume of loans facilitated through our platform and originated by our issuing banks is a key indicator of the attractiveness of our lending marketplace, growth of our brand, scale of our business, economic competitiveness of our products and future growth.
We classify the loans facilitated by our platform into three major loan products: standard program personal loans, custom program personal loans and other loans. The majority of the loans facilitated through our platform are standard program personal loans that represent loans made to prime borrowers that are available to institutional investors, private investors and public investors (in the form of member payment dependent notes). Custom program personal loans include all other personal loans to borrowers who are not eligible for our standard program, including loans primarily made to near-prime and super-prime borrowers, and are available only to private investors. Other loans are comprised of education and patient finance loans, auto refinance loans, and small business loans. In the second quarter of 2019, the Company announced that it will connect applicants looking for a small business loan with strategic partners and earn referral fees, instead of facilitating these loans on its platform. As a result, beginning in the third quarter of 2019 the “Other loans” category presented in the table below no longer includes small business loans.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Loan origination volume and weighted-average transaction fees (as a percent of origination balance) by major loan products are as follows:
The increase in the total weighted-average transaction fee in 2019 compared to 2018 was primarily driven by higher average transaction fees at certain grade levels within the standard program.
Personal loan origination volume for our standard loan program by loan grade was as follows (in millions):
N/M - Not meaningful
Credit and pricing policy changes made by the Company during 2019 resulted in a change in the mix of personal loan origination volume from higher risk grades E through G to lower risk A through D grades. These changes broadly focused on tightening credit to shift overall platform mix towards lower risk and higher credit quality borrowers.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Results of Operations
This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. For discussion related to 2017 items and year-over-year comparisons between 2018 and 2017, see “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2018.
The following table sets forth the Consolidated Statements of Operations data for each of the periods presented:
(1)
See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 1. Basis of Presentation” for additional information.
(2) Includes stock-based compensation expense as follows:
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Total Net Revenue
N/M - Not meaningful
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Transaction Fees
Transaction fees are fees paid by issuing banks or education and patient service providers to us for the work we perform in facilitating the origination of loans by our issuing bank partners. With respect to all unsecured personal loans and auto refinance loans for which WebBank acts as the issuing bank, we record transaction fee revenue net of program fees paid to WebBank. The fees on these loans are based upon the terms of the loan, including grade, rate, term, channel and other factors. As of December 31, 2019, these fees ranged from 0% to 6% of the initial principal amount of a loan.
Transaction fees were $598.8 million and $526.9 million for the years ended December 31, 2019 and 2018, respectively, an increase of 14%. The increase was primarily due to higher origination volume and a higher weighted-average transaction fee. Loans facilitated through our lending marketplace increased to $12.3 billion for the year ended December 31, 2019 compared to $10.9 billion for the year ended December 31, 2018, an increase of 13%. The average transaction fee as a percentage of the initial principal balance of the loan was 4.87% in 2019 compared to 4.84% in 2018.
In January 2020, we recognized approximately $3.6 million in transaction fee revenue associated with the issuance of loans for which the loan application process had commenced prior to the end of 2019. In January 2019, we recognized approximately $4.2 million in transaction fee revenue associated with the issuance of loans for which the loan application process had commenced prior to the end of 2018. In January 2018, we recognized approximately $5.5 million in transaction fee revenue associated with the issuance of loans for which the loan application process had commenced prior to the end of 2017.
Net Interest Income and Fair Value Adjustments
Loans Invested in by the Company: The Company purchases loans to support Structured Program transactions. We earn interest income and assume principal and interest rate risk on loans during the period we own the loans. We have financed a portion of the purchase of these loans with draws on our credit facilities and the associated interest expense reduces net interest income. Fair value adjustments on loans invested in by the Company are generally negative due to interest cash flow receipts and if there are expected increases and any acceleration in the timing of expected charge-offs and prepayments. As we continue to use our own capital to invest in loans for strategic business purposes, we expect the net negative fair value adjustments on loans to fluctuate due to the impact of discounts offered to meet yield expectations of our loan investors and the holding period of the loans.
Loans, Notes, Certificates and Secured Borrowings: We do not assume principal or interest rate risk on loans facilitated through our lending marketplace that are funded by notes, certificates and certain secured borrowings because loan balances, interest rates and maturities are matched and offset by an equal balance of notes, certificates or secured borrowings with the exact same interest rates and maturities. The changes in fair value of loans, notes, certificates and secured borrowings are shown on our Consolidated Statements of Operations on a net basis. Due to the payment dependent feature of the notes, certificates and secured borrowings, fair value adjustments on loans funded with notes, certificates and secured borrowings result in no net effect on our earnings, except for changes in fair value of any applicable credit support agreements related to secured borrowings.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following tables provide additional detail related to net interest income and fair value adjustments for assets invested in by the Company, assets with equal and offsetting liabilities, and total interest income, interest expense and net fair value adjustments:
N/M - Not meaningful
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
N/M - Not meaningful
The following tables provide the outstanding average balances, which are key drivers of interest income and interest expense in the periods presented:
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
N/M - Not meaningful
Interest income associated with loans invested in by the Company, securities available for sale, and cash, cash equivalents and restricted cash was $131.0 million and $125.3 million for the years ended December 31, 2019 and 2018, respectively an increase of 5%. The increase was primarily due to an increase in the average outstanding balance of securities available for sale. The impact of the increase in the outstanding balance of loans invested in by the Company was offset by the mix shift to higher credit quality loans with lower interest rates.
Interest expense associated with credit facilities, securities sold under repurchase agreements and securitization notes was $32.2 million and $23.4 million for the years ended December 31, 2019 and 2018, respectively, an increase of 37%. The increase was primarily due to an increase in the average outstanding balance of credit facilities, partially offset by a decrease in the average outstanding balances of securitization notes and certificates.
Net fair value adjustments were $(145.0) million and $(100.7) million for the years ended December 31, 2019 and 2018, respectively, an increase of 44%. The increase was primarily due to increases in the average outstanding balances and investor required yields related to certain loans invested in by the Company to support Structured Program transactions and whole loan sales, partially offset by a shift in overall platform mix towards lower risk and higher credit quality borrowers.
Interest income from loans held for investment and the offsetting interest expense from notes, certificates and secured borrowings were both $214.4 million and $362.2 million for the years ended December 31, 2019 and 2018, respectively, a decrease of 41%. The decrease was primarily due to a decrease in the average outstanding balances of loans held for investment and notes, certificates and secured borrowings, due to a larger portion of loans originated being sold to whole loan investors and purchases by the Company for Structured Program transactions.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Investor Fees
The tables below illustrate the composition of investor fees and the outstanding principal balance of loans serviced, which is a key driver of investor fees, by the method in which the loans were financed for each period presented:
(1)
Funds are the private funds for which LendingClub Asset Management, LLC (LCAM), or its subsidiaries acted as general partner. In March 2019, we completed the dissolution of those funds. The Company does not expect to earn investor fees from private funds and separately managed accounts in the future.
(2)
As of the end of each respective period.
(1)
Funds are the private funds for which LendingClub Asset Management, LLC (LCAM), or its subsidiaries acted as general partner. In March 2019, we completed the dissolution of those funds. The Company does not expect to earn investor fees from private funds and separately managed accounts in the future.
(2) As of the end of each respective period.
The Company receives fees to compensate us for the costs we incur in servicing a loan, including managing payments from borrowers, collections, payments to investors, maintaining investors’ account portfolios, providing information, and issuing monthly statements. The amount of investor fee revenue earned is predominantly affected
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
by the servicing rates paid by investors, the outstanding principal balance of loans and the amount of principal and interest collected from borrowers and remitted to investors.
Investor fee revenue related to whole loans sold also includes the change in fair value of our servicing assets and liabilities associated with the loans. Servicing rights are recorded as either an asset or liability in “Gain on sales of loans” in the Company’s Consolidated Statements of Operations.
Investor fees - whole loans sold: Investor fee revenue related to the servicing of whole loans sold was $100.1 million and $82.8 million for the years ended December 31, 2019 and 2018, respectively, an increase of 21%. The increase was primarily due to a higher principal balance of whole loans serviced and increases in delinquent loan collections and charged-off loan sales, partially offset by the change in fair value of servicing rights.
Investor fees - notes, certificates and secured borrowings: Investor fee revenue related to the servicing of loans underlying notes, certificates and secured borrowings was $24.4 million and $32.0 million for the years ended December 31, 2019 and 2018, respectively, a decrease of 24%. The decrease was primarily due to a lower principal balance of loans serviced and a decrease in charged-off loan sales, partially offset by an increase in delinquent loan collections.
Investor fees - Funds and separately managed accounts: In July 2016, certain of the private funds ceased accepting contributions and limited existing investors’ ability to make redemption requests, pursuant to the terms of the respective limited partnership agreements, and in October 2017 we completed the dissolution of those funds. In October 2018, LCAM initiated the liquidation of the remaining private funds it manages. As a result, the assets under management associated with those funds were returned to investors and liquidation of those funds was complete as of December 31, 2018. The Company does not expect to earn investor fees from private funds and separately managed accounts in the future.
Gain (Loss) on Sales of Loans
In connection with loan sales and Structured Program transactions, in addition to investor fees earned with respect to the corresponding loan, we recognize a gain or loss on the sale of that loan based on the level to which the contractual loan servicing fee is above or below an estimated market rate loan servicing fee. Additionally, we recognize transactions costs as a loss on sale of loans.
Gain on sales of loans was $67.7 million and $46.0 million for the years ended December 31, 2019 and 2018, respectively, an increase of 47%. The increase was primarily due to an increase in the volume of loans sold and an increase in the weighted-average contractual loan servicing fee that resulted in higher gains on sales of loans.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Other Revenue
Other revenue primarily consists of referral revenue that relates to fees earned from third-party companies when customers referred by us consider or purchase products or services from such third-party companies, and sublease revenue from our sublet office space in San Francisco, California. The table below illustrates the composition of other revenue for each period presented:
N/M - Not meaningful
(1)
Beginning in the first quarter of 2019, the Company separately reported “Sublease revenue” from “Other” in the tables above. Prior period amounts have been reclassified to conform to the current period presentation.
Operating Expenses
Our operating expenses consist of sales and marketing, origination and servicing, engineering and product development and other general and administrative expenses, as described below.
Sales and Marketing: Sales and marketing expense consists primarily of borrower and investor acquisition efforts, including costs attributable to marketing and selling the loans facilitated through the platform we operate. This includes costs of building general brand awareness, and salaries, benefits and stock-based compensation expense related to our sales and marketing team.
Origination and Servicing: Origination and servicing expense consists primarily of salaries, benefits and stock-based compensation expense and vendor costs attributable to activities that most directly relate to facilitating the origination of loans and servicing loans for borrowers and investors. These costs relate to the credit, collections, customer support and payment processing teams and related vendors.
Engineering and Product Development: Engineering and product development expense consists primarily of salaries, benefits and stock-based compensation expense for our engineering and product management teams, and the cost of contractors who work on the development and maintenance of our platform. Engineering and product development expense also includes non-capitalized hardware and software costs and depreciation, amortization and impairment of technology assets.
Other General and Administrative: Other general and administrative expense consists primarily of salaries, benefits and stock-based compensation expense for our accounting, finance, legal, risk, compliance, human resources and facilities teams, professional services fees and facilities expense.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
N/M - Not meaningful
Sales and marketing: Sales and marketing expense was $279.4 million and $268.5 million for the years ended December 31, 2019 and 2018, respectively, an increase of 4%. The increase was primarily due to an increase in variable marketing expense based on higher loan origination volume, partially offset by a decrease in personnel-related expenses for full-time employees. Sales and marketing expense as a percent of loan originations decreased to 2.27% in 2019 from 2.47% in 2018 as a result of the Company’s cost structure simplification efforts, as well as improvements in customer acquisition targeting models.
Origination and servicing: Origination and servicing expense was $103.4 million and $99.4 million for the years ended December 31, 2019 and 2018, respectively, an increase of 4%. The increase was primarily due to incremental personnel-related expenses associated with establishing a site in the Salt Lake City area. Personnel-related expenses for full-time employees decreased from 2018, which was partially offset by an increased use of outsourced service providers.
Engineering and product development: Engineering and product development expense was $168.4 million and $155.3 million for the years ended December 31, 2019 and 2018, respectively, an increase of 8%. The increase was primarily driven by continued investment in technology and platform improvements that are focused on enhancing our credit decisioning capabilities, internal testing environment and cloud infrastructure, which included increases in depreciation and impairment expense and equipment and software expense. Personnel-related expenses for full-time employees decreased from 2018, which was partially offset by an increased use of outsourced service providers.
We capitalized $36.1 million and $46.8 million in software development costs for the years ended December 31, 2019 and 2018, respectively.
Other general and administrative expense: Other general and administrative expense was $238.3 million and $228.6 million for the years ended December 31, 2019 and 2018, respectively, an increase of 4%. The increase was primarily due to an increase in personnel-related expenses resulting from a higher headcount of full-time employees, an expense related to the termination of a legacy contract in the second quarter of 2019 and an increase
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
in facilities expense, partially offset by a reduction in professional services and external advisory fees. The increase in facilities expense was primarily associated with establishing a site in the Salt Lake City area and having the offsetting sublease revenue from our sublet office space in San Francisco, California, recorded in Other revenue in the Company’s Consolidated Statements of Operations.
Goodwill Impairment
In 2018, we had one reporting unit for goodwill impairment testing purposes, the patient and education finance reporting unit. We performed a quantitative annual test for impairment on April 1, 2018 and recorded a goodwill impairment expense of $35.6 million in the second quarter of 2018, resulting in full impairment of the remaining goodwill.
Class Action and Regulatory Litigation Expense
There was no class action and regulatory litigation expense related to legacy issues for the year ended December 31, 2019. Class action and regulatory litigation expense for the year ended December 31, 2018 was $35.5 million, which is included in “Class action and regulatory litigation expense” on the Company’s Consolidated Statements of Operations. This expense was related to significant governmental and regulatory investigations following the internal board review described more fully in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Board Review” contained in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Income Taxes
Income tax expense (benefit) is primarily attributable to the tax effects of unrealized gains recorded to other comprehensive income associated with the Company’s available for sale portfolio and current state income taxes. We continue to recognize a full valuation allowance against net deferred tax assets. This determination was based on the assessment of the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. As of December 31, 2019 and 2018, the valuation allowance was $169.5 million and $169.3 million, respectively. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances.
Non-GAAP Financial Measures and Supplemental Financial Information
We use certain non-GAAP financial measures in evaluating our operating results. We believe that Contribution, Contribution Margin, Adjusted Net Income (Loss), Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Earnings (Loss) Per Share (Adjusted EPS) and Net Cash and Other Financial Assets help identify trends in our core business results and allow for greater transparency with respect to key metrics used by our management in its decision making.
Our non-GAAP measures have limitations as analytical tools and you should not consider them in isolation. These non-GAAP measures should not be viewed as substitutes for, or superior to, net income (loss) as prepared in accordance with GAAP. In evaluating these non-GAAP measures, you should be aware that in the future we will incur expenses similar to the adjustments in this presentation. There are a number of limitations related to the use of these non-GAAP financial measures versus their most directly comparable GAAP measures, which include the following:
•
Other companies, including companies in our industry, may calculate these measures differently, which may reduce their usefulness as a comparative measure.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
•
Although depreciation, impairment and amortization are non-cash charges, the assets being depreciated, impaired and amortized may have to be replaced in the future and Adjusted EBITDA and Adjusted EBITDA Margin do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements.
•
These measures do not reflect tax payments that may represent a reduction in cash available to us.
Contribution and Contribution Margin
Contribution is a non-GAAP financial measure that is calculated as net revenue less “Sales and marketing” and “Origination and servicing” expenses on the Company’s Consolidated Statements of Operations, adjusted to exclude cost structure simplification and non-cash stock-based compensation expenses within these captions and income or loss attributable to noncontrolling interests. These costs represent the costs that are most directly related to generating such revenue. The adjustment for cost structure simplification expense relates to a review of our cost structure and a number of expense initiatives underway, including the establishment of a site in the Salt Lake City area. The expense includes incremental and excess personnel-related expenses associated with establishing our Salt Lake City area site and external advisory fees. Contribution margin is a non-GAAP financial measure calculated by dividing Contribution by total net revenue.
Contribution and Contribution Margin are measures of overall direct product profitability that our management and board of directors find useful, and believe investors may find useful, in understanding the relationship between costs most directly associated with revenue generating activities and the related revenue, and remaining amount available to support our costs of engineering and product development and other general and administrative expense to evaluate our operating performance and trends. While we believe Contribution and Contribution Margin are useful for the reasons above, they are not an overall measure of our profitability, as they exclude engineering and product development and other general and administrative expenses that are required to run our business. Factors that affect our Contribution and Contribution Margin include revenue mix, variable marketing expenses and origination and servicing expenses.
The following table shows the calculation of Contribution and Contribution Margin:
(1)
Contribution excludes the portion of personnel-related expense associated with establishing a site in the Salt Lake City area that is included in the “Sales and marketing” and “Origination and servicing” expense categories.
(2)
Contribution excludes stock-based compensation expense included in the “Sales and marketing” and “Origination and servicing” expense categories.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table presents a reconciliation of LendingClub net loss to Contribution for each of the periods indicated:
(1)
Contribution excludes the portion of personnel-related expenses associated with establishing a site in the Salt Lake City area that are included in the “Sales and marketing” and “Origination and servicing” expense categories.
(2)
Contribution excludes stock-based compensation expense included in the “Sales and marketing” and “Origination and servicing” expense categories.
Adjusted Net Income (Loss), Adjusted EBITDA, Adjusted EBITDA Margin and Adjusted EPS
Adjusted Net Income (Loss) is a non-GAAP financial measure defined as net income (loss) attributable to LendingClub adjusted to exclude certain items that are either non-recurring, do not contribute directly to management’s evaluation of its operating results, or non-cash items, such as (1) expenses related to our cost structure simplification, as discussed above, (2) goodwill impairment, (3) legal, regulatory and other expense related to legacy issues, (4) acquisition and related expenses and (5) other items (consisting of certain non-legacy litigation and/or regulatory settlement expenses and gains on disposal of certain assets), net of tax. Legacy items are generally those expenses that arose from the decisions of legacy management prior to the board review initiated in 2016 and resulted in the resignation of our former CEO, including legal and other costs associated with ongoing regulatory and government investigations, indemnification obligations, litigation, and termination of certain legacy contracts. In the fourth quarter of 2019, we added an adjustment to Adjusted Net Income (Loss) for “Acquisition and related expenses” to adjust for costs related to the acquisition of Radius. In the second quarter of 2019, we added an adjustment to Adjusted Net Income (Loss) and Adjusted EBITDA for “Other items” to adjust for expenses or gains that are not part of our core operating results. We believe Adjusted Net Income (Loss) is an important measure because it directly reflects the financial performance of our business.
Adjusted EBITDA is a non-GAAP financial measure defined as net income (loss) attributable to LendingClub adjusted to exclude certain items that are either non-recurring, do not contribute directly to management's evaluation of its operating results, or non-cash items, such as (1) cost structure simplification expense, (2) goodwill impairment, (3) legal, regulatory and other expense related to legacy issues, (4) acquisition and related expenses, (5) other items, as discussed above, (6) depreciation, impairment and amortization expense, (7) stock-based compensation expense and (8) income tax expense (benefit). We believe that Adjusted EBITDA is an important measure of operating performance because it allows management, investors and our board to evaluate and compare our core operating results, including our return on capital and operating efficiencies, from period to period. Additionally, we utilize Adjusted EBITDA as an input into the Company’s calculation of the annual bonus plan.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Adjusted EBITDA Margin is a non-GAAP financial measure calculated by dividing Adjusted EBITDA by total net revenue.
Adjusted EPS is a non-GAAP financial measure calculated by dividing Adjusted Net Income (Loss) by the weighted-average diluted common shares outstanding. We believe that Adjusted EPS is an important measure because it directly reflects the core operating results of our business on a per share basis.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table presents a reconciliation of LendingClub net loss to Adjusted Net Income (Loss) and Adjusted EBITDA and a calculation of Adjusted EPS for each of the periods indicated:
(1)
Includes personnel-related expenses associated with establishing a site in the Salt Lake City area and external advisory fees. These expenses are included in “Sales and marketing,” “Origination and servicing,” “Engineering and product development” and “Other general and administrative” expense on the Company’s Consolidated Statements of Operations. In the fourth quarter of 2018 and first quarter of 2019, also includes external advisory fees which are included in “Other general and administrative” expense on the Company’s Consolidated Statements of Operations.
(2)
In 2019, includes legacy legal expenses, expense related to the dissolution of certain private funds previously managed by LCAM, and expense related to the termination of a legacy contract, which are included in “Other general and administrative” expense, “Net fair value adjustments,” and “Other general and administrative” expense on the Company’s Consolidated Statements of Operations, respectively. Includes class action and regulatory litigation expense of $35.5 million and $77.3 million for the years ended December 31, 2018 and 2017, respectively, which is included in “Class action and regulatory litigation expense” on the Company’s Consolidated Statements of Operations. In 2018 and 2017, also includes legacy legal expenses which are included in “Other general and administrative” expense on the Company’s Consolidated Statements of Operations.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
(3)
In 2019, represents costs related to the acquisition of Radius. In 2017, represents incremental compensation expense required to be paid under the purchase agreement to retain key former shareholder employees of an acquired business.
(4)
In 2019, consists of expenses related to certain non-legacy litigation and regulatory matters, which are included in “Other general and administrative” expense on the Company’s Consolidated Statements of Operations. Also includes a gain on the sale of our small business operating segment.
(5)
All share and per share information has been retroactively adjusted to reflect a reverse stock split. See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Supplemental Financial Information
The following table is provided to delineate between the assets and liabilities belonging to our member payment dependent self-directed retail program (Retail Program) note holders and certain VIEs that we are required to consolidate in accordance with GAAP. Such assets are not legally ours and the associated liabilities are payable only from the cash flows generated by those assets (i.e. Pass-throughs). As such, these debt holders do not have a secured interest in any other assets of LendingClub. We believe this is a useful measure because it illustrates the overall financial stability and operating leverage of the Company.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
(1) Represents loans held for investment at fair value that are funded directly by our Retail Program notes. The liabilities are only payable from the cash flows generated by the associated assets. We do not assume principal or interest rate risk on loans facilitated through our lending marketplace that are funded by our Retail Program because loan balances, interest rates and maturities are matched and offset by an equal balance of notes with the exact same interest rates and maturities. We do not retain any economic interests from our Retail Program. Interest expense on Retail Program notes of $148.0 million and $210.8 million was equally matched and offset by interest income from the related loans of $148.0 million and $210.8 million in 2019 and 2018, respectively, resulting in no net effect on our Net interest income and fair value adjustments.
(2) Represents assets and equal and offsetting liabilities of certain VIEs that we are required to consolidate in accordance with GAAP, but which are not legally ours. The liabilities are only payable from the cash flows generated by the associated assets. The creditors of the VIEs have no recourse to the general credit of the Company. Interest expense on these liabilities owned by third parties of $70.8 million and net fair value adjustments of $13.5 million in 2019 were equally matched and offset by interest income on the loans of $84.3 million, resulting in no net effect on our Net interest income and fair value adjustments. Interest expense on these liabilities owned by third parties of $154.9 million and net fair value adjustments of $15.9 million in 2018 were equally matched and offset by interest income on the loans of $170.8 million, resulting in no net effect on our Net interest income and fair value adjustments. Economic interests held by LendingClub, including retained interests, residuals and equity of the VIEs, are reflected in “Loans held for sale by the Company at fair value,” “Loans held for investment by the Company at fair value” and “Restricted cash,” respectively, within the “All Other LendingClub” column.
(3) Represents all other assets and liabilities of LendingClub, other than those related to our Retail Program and certain consolidated VIEs, but includes any economic interests held by LendingClub, including retained interests, residuals and equity of those consolidated VIEs.
(4)
In the fourth quarter of 2019, the Company sponsored a new Structured Program transaction that was consolidated, resulting in an increase to “Loans held for investment by the Company at fair value” and the related “Payable to securitization note and certificate holders.” See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 14. Debt” for additional information.
(5)
In the fourth quarter of 2019, the Company presented operating lease assets and operating lease liabilities separately from “Other assets” and “Accrued expenses and other liabilities,” respectively, on its Consolidated Balance Sheets. This change in presentation had no impact on prior period amounts presented.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Net Cash and Other Financial Assets
The following table provides additional detail related to components of our Net Cash and Other Financial assets. We believe Net Cash and Other Financial Assets is a useful measure because it illustrates the overall financial stability and operating leverage of the Company. This measure is calculated as cash and certain other assets and liabilities, including loans and securities available for sale, which are partially secured and offset by related credit facilities, and working capital.
(1) Variations in cash and cash equivalents are primarily due to variations in the amount and timing of loan purchases invested in by the Company.
(2) In the fourth quarter of 2019, we added a new line item called “Other assets and liabilities” which is a total of “Accrued interest receivable,” “Other assets,” “Accounts payable,” “Accrued interest payable” and “Accrued expenses and other liabilities,” included on our Consolidated Balance Sheets. This line item represents certain assets and liabilities that impact working capital and are affected by timing differences between revenue and expense recognition and related cash activity. In the third quarter of 2019, we added a new line item called “Restricted cash committed for loan purchases,” which represents cash and cash equivalents that are transferred to restricted cash for loans that are pending purchase by the Company. We believe this is a more complete representation of the Company’s net cash and other financial assets position as of each period presented in the table above. Prior period amounts have been reclassified to conform to the current period presentation.
(3)
In the fourth quarter of 2019, the Company sponsored a new Structured Program transaction that was consolidated, resulting in an increase to “Loans held for investment by the Company at fair value” and the related “Payable to securitization note and certificate holders.” See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 14. Debt” for additional information.
(4) Comparable GAAP measure cannot be provided as not practicable.
Investments in Quarterly Originations by Investment Channel and Investor Concentration
Our investment channels consist of (1) Banks, which are deposit taking institutions or their affiliates, (2) LendingClub inventory, which includes loan originations purchased by the Company during the period and not yet sold as of the period end, (3) Other institutional investors and Managed accounts, which primarily include other non-bank investors, dedicated third-party funds, and public and private funds managed by third-party asset managers, and (4) self-directed retail investors.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table shows the percentage of loan origination volume issued in the period and purchased or pending purchase by each investment channel as of the end of each period presented:
(1)
LendingClub inventory reflects loans purchased or pending purchase by the Company during the period, excluding loans held by the Company through consolidated trusts, if applicable, and not yet sold as of the period end.
The Company strategically tightened credit underwriting throughout 2019. An increase in annual volume in our business and a shift in mix to higher quality grade A and B borrowers resulted in changes to proportional purchases by investor type. The proportional reduction in the Bank investors’ share of our marketplace has been primarily offset by a proportional increase in LendingClub inventory targeted for the Company’s Structured Program and a proportional increase in purchases by institutional investors. During the fourth quarter of 2019, the Company sponsored its first securitization of exclusively grade A and B loans to attract a wider range of loan investors.
The following table provides the percentage of loans invested in by the ten largest external investors and by the largest single investor during each of the previous five quarters (by dollars invested):
The composition of the top ten investors may vary from period to period. During 2019, the Company made multiple efforts to reduce its concentration of investors by introducing several new products in its Structured Program, including Levered Certificates, LCX and a securitization of exclusively grade A and B loans. The percentage of loans invested in by our ten largest investors decreased 4% from the third quarter of 2019 primarily due to a decrease in loans purchased by banks, as well as reducing our concentration to our largest investor. Our largest investor continues to invest in loans, but not at the same proportional level due primarily to the Company’s increased annual loan volume.
Effectiveness of Scoring Models
Our ability to attract borrowers and investors to our lending marketplace is significantly dependent on our platform’s ability to effectively evaluate a borrower’s credit profile.
Our online lending marketplace platform’s credit decisioning and scoring models are evaluated on a regular basis and the additional data on loan history experience, borrower behavior and prepayment trends that we accumulate are leveraged to continually improve our underwriting models. We believe we have the experience to effectively
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
evaluate a borrower’s creditworthiness and likelihood of default. If our lending marketplace’s credit decisioning and scoring models ultimately prove to be ineffective or fail to appropriately account for a decline in future macroeconomic environment, investors may experience higher than expected losses.
Our current underwriting model leverages a number of custom attributes developed by LendingClub. We work with our primary issuing bank partner to modify their credit and pricing policies, leveraging insights on current market conditions and recent vintage performance.
The charts provided below display the historical lifetime cumulative net charge-off rates (expressed as a percent of original loan balances) through December 31, 2019, by booking year, for all standard program loans and 36-month or 60-month terms for each of the years shown. The charts display lifetime cumulative net charge-off rates using months on book for each annual vintage presented. Each annual vintage’s lifetime cumulative net charge-offs vary based on the maturity of each loan’s month on book. In the fourth quarter and year ended December 31, 2019, standard program loans accounted for 68% and 69%, respectively, of all loan origination volume.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Loan Portfolio Information and Credit Metrics
Fair Value and Delinquencies
For loans held for investment that are backed by notes, certificates and secured borrowings on our Consolidated Balance Sheets, the outstanding principal balance, fair value and percentage of loans that are delinquent, by loan product, are as follows:
(1)
Components of other loans are less than 10% of the outstanding principal balance presented individually.
(2)
Expressed as a percent of outstanding principal balance.
Increases in the fair value of loans as a percent of outstanding principal balance from December 31, 2018 to December 31, 2019 were primarily due to a shift in the mix of personal loans toward lower risk grades.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
For loans invested in directly by the Company for which there were no associated notes, certificates or secured borrowings, the outstanding principal balance, fair value and percentage of loans that are delinquent, by loan product, are as follows:
(1)
Components of other loans are less than 10% of the outstanding principal balance if presented individually.
(2)
Includes both loans held for investment and loans held for sale.
(3)
Expressed as a percent of outstanding principal balance.
The fair value of total loans invested in by the Company as a percent of outstanding principal balance from December 31, 2018 to December 31, 2019 remained relatively unchanged due to an increase in fair value as a result of a shift in portfolio mix to higher volume in lower risk grades, offset by higher discounts.
Net Annualized Charge-Off Rates
The following tables show annualized net charge-off rates, which are a measure of the performance of the loans facilitated by our platform. In contrast to the graphs above, these tables show the annualized charged-off balance of loans in a specific period as a percentage of the average outstanding balance for such period.
Net annualized charge-off rates are affected by the average age and grade distribution of the loans outstanding for a given quarter and the credit performance of those loans. Additionally, in any particular quarter the portfolios include loans from past vintages that were originated under prior credit underwriting parameters, and thus do not reflect the current credit underwriting parameters used to originate new loans.
The annualized net charge-off rates for personal loans for both standard and custom programs in total for the last five quarters were as follows:
(1)
Total platform comprises all loans facilitated through our lending marketplace, including whole loans sold and loans financed by notes, certificates and secured borrowings, but excluding education and patient finance loans, auto refinance loans and small business loans.
The decrease in the annualized net charge-off rate in the fourth quarter of 2019 compared to the fourth quarter of 2018 for the total platform custom personal loan program primarily reflects the effect of a greater increase in
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
outstanding loan balances (and a higher mix of lower risk loans) proportionate to the increase in actual net charge-offs.
The increase in the annualized net charge-off rates in the fourth quarter of 2019 compared to the third quarter of 2019 for both the standard and custom personal loan programs reflects the effect of higher outstanding loan balances and a seasonal increase in actual net charge-offs.
The annualized net charge-off rates for personal loans for both standard and custom programs for loans retained on our Consolidated Balance Sheets for the last five quarters were as follows:
(1)
Loans retained on balance sheet include loans invested in by the Company as well as loans held for investment that are funded directly by member payment dependent notes related to our Retail Program and certificates.
The decrease in annualized net charge-off rates for the standard personal loan program in the fourth quarter of 2019 compared to the fourth quarter of 2018 for the loans retained on our Consolidated Balance Sheets reflects the effect of lower outstanding loan balances and a decrease in actual net charge-offs.
The increase in the annualized net charge-off rate in the fourth quarter of 2019 compared to the third quarter of 2019 for the standard personal loan program is primarily due the effect of a decrease in outstanding loan balances.
The annualized net charge-off rates and weighted-average age in months for custom program loans retained on our Consolidated Balance Sheets reflect the change in outstanding principal balance period-over-period based on purchase and sale activity of recently issued near-prime loans.
The annualized net charge-off rates for standard program loans are higher for loans retained on our Consolidated Balance Sheets compared to loans reflected at the total platform level for each quarter because of, among other reasons, a difference in grade distribution for the two portfolios. The proportion of grade A and B loans is 55% of the retained loan portfolio compared to 57% for the total platform level as of December 31, 2019. This difference in loan grade distribution results in higher net charge-off rates for the loans on the Consolidated Balance Sheets compared to the total platform, as grade A and B loans have lower expected and actual credit losses.
Regulatory Environment
We are regularly subject to claims, individual and class action lawsuits, lawsuits alleging regulatory violations, government (including state agencies) and regulatory exams, investigations, inquiries or requests, and other proceedings. The number and significance of these claims, lawsuits, exams, investigations, inquiries, requests and proceedings have increased in part because our business has expanded in scope and geographic reach, and our products and services have increased in complexity. For example, we have experienced, are currently and will likely continue to be subject to and experience exams from state regulators, and our legal, compliance and other costs related to such proceedings may elevate from current levels. See “Part I - Item 1. Business - Regulatory and Compliance Framework,” “Part I - Item 1A. Risk Factors - Risks Related to Our Business and Regulation,”
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
including the risk factors titled “We are regularly subject to litigation, and government and regulatory investigations, inquiries and requests,” “If the loans facilitated through our lending marketplace were found to violate a state’s usury laws, and/or we were found to be the true lender (as opposed to our issuing bank(s)), we may have to alter our business model and our business could be harmed” and “The regulatory framework for our business is evolving and uncertain as federal and state governments consider new laws to regulate online lending marketplaces such as ours. New laws and regulations, including uncertainty as to how the actions of any federal or state regulator could impact our business or that of our issuing bank(s).” for more information, additional discussion and disclosure, including the potential adverse outcomes and consequences from such proceedings.
Bank Partnership Model
There has been (and may continue to be) an increase in inquiries, regulatory proceedings, including exams by state regulators, and litigation challenging or raising issues relating to, among other things, the application of state usury rates and lending arrangements where a bank or other third party has made a loan and then sells and assigns it to an entity that is engaged in assisting with the origination or servicing of a loan.
For example, in January 2017, the Colorado Administrator (Administrator) of the Uniform Consumer Credit Code filed suit against Avant, Inc., a company that operates an online consumer loan platform. The Administrator asserts that loans to Colorado residents facilitated through Avant’s platform were required to comply with Colorado laws regarding interest rates and fees, and that those laws were not preempted by federal laws that apply to loans originated by WebBank, the federally regulated issuing bank who originates loans through Avant’s platform, as well as through our platform. Although Avant removed its case to federal court in March 2017, the United States District Court for the District of Colorado issued an order in March 2018 remanding the case to the District Court for the City and County of Denver. In March 2018, the United States District Court for the District of Colorado also issued an order dismissing a parallel case brought by WebBank that sought a declaratory judgment regarding the applicability of preemption to Colorado usury laws and permanent injunctions against the Administrator that would prevent the Administrator from enforcing Colorado usury laws against WebBank and certain parties associated with loans originated by it. Avant thereafter filed a Motion to Dismiss in District Court for the State of Colorado and WebBank moved to intervene in the case. In August 2018, the Court granted WebBank’s motion but denied Avant’s motion. In November 2018, the Administrator added as defendants certain securitization trusts that had acquired Avant loans. The Administrator is seeking a penalty of ten times the amount of the “excess” finance charges. Trials in this case and in a similar case pending in Colorado against Marlette Funding and Cross River Bank are currently scheduled for Spring 2020.
See “Part I - Item 1. Business - Regulatory and Compliance Framework - Current Regulatory Environment” for more information, additional discussion and disclosure regarding relevant third-party litigation and related matters.
Although we believe that our program is factually distinguishable from the Madden case, an extension of the application of the Second Circuit's decision, either within or outside the states in the Second Circuit, could challenge the federal preemption of state laws setting interest rate limitations for loans made by issuing bank partners in those states.
State Inquiries and Licensing
There has been (and may continue to be) an increase in inquiries and regulatory proceedings, including exams by state regulators, with respect to licensing requirements. In most states we believe, because of our issuing bank model, we are exempt from or satisfy relevant licensing requirements with respect to the origination of loans we facilitate. However, as needed, we have endeavored to apply and obtain the appropriate licenses.
The Company has had discussions with the Colorado Department of Law (CDL) concerning the licenses required for the Company’s servicing operations and the structure of its offerings in the State of Colorado. While we believe
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
that our program with WebBank has been structured in accordance with governing federal law, the Administrator has identified alleged “exceptions” to our compliance with provisions of the Colorado Uniform Consumer Credit Code, including with respect to permitted rates and charges. We believe that our model differs in important respects from Avant’s business model as alleged in the litigation involving Avant in Colorado. We have also had discussions with the CDL about entering into a terminable agreement with the CDL to, among other things: (i) toll the statutes of limitations on any action the CDL might bring against the Company based on the rates and charges on loans the Company facilitates and (ii) refrain from facilitating certain loans to borrowers located in Colorado available for investment by certain investors. No assurances can be given as to the timing, outcome or consequences of this matter.
We are routinely subject to examination for compliance with applicable laws and regulations in the states in which we are licensed. As of the date of this Report, we are subject to examination by the New York Department of Financial Services (NYDFS). In July 2018, the NYDFS issued an Online Lending Report (Lending Report). The Lending Report included, among other things, an analysis of the online lenders operating in New York including their methods of operations, lending practices, interest rates and costs, products offered and complaints and investigations relating to online lenders. The Lending Report also included information and recommendations regarding protecting New York’s markets and consumers. For example, although the Lending Report noted that the rapid growth of online lending demonstrates there is value to new technologies that allow financial institutions to connect with borrowers in new ways, it noted that in many cases an online lender is the “true lender” and that lending in New York, whether through banks, credit unions or online lenders, should be subject to applicable usury limits. We periodically have discussions with various regulatory agencies regarding our business model and have recently engaged in similar discussions with the NYDFS. During the course of such discussions, which remain ongoing, we decided to voluntarily comply with certain rules and regulations of the NYDFS. No assurances can be given as to the timing, outcome or consequences of this matter.
The Company has undertaken a review of its portfolio of licenses and has had discussions with regulators in Texas, Arizona, New York, Florida and North Dakota concerning the licenses required for the Company’s issuance of retail notes to investors in these states and has applied for licenses in these states to facilitate these operations. The Company has also had discussions with certain of these regulators to resolve concerns regarding the Company’s historical licensing/registration status in connection with retail notes issued. Although the Company is not able to predict with certainty the timing, outcome, or consequence of these discussions, the Company expects to receive permission to re-enter certain states in the near future. Discussions with these states could result in fines or other penalties, which are not expected to have a material adverse impact on the Company’s operations or results of operations.
Consequences
If we are found to not have complied with applicable laws, regulations or requirements, we could: (i) lose one or more of our licenses or authorizations, (ii) become subject to a consent order or administrative enforcement action, (iii) face lawsuits (including class action lawsuits), sanctions or penalties, (iv) be in breach of certain contracts, which may void or cancel such contracts, (v) decide or be compelled to modify or suspend certain of our business practices (including limiting the maximum interest rate on certain loans facilitated through our platform and/or refraining from making certain loans available for investment by certain investors), or (vi) be required to obtain a license in such jurisdiction, which may have an adverse effect on our ability to continue to facilitate loans through our lending marketplace, perform our servicing obligations or make our lending marketplace available to borrowers in particular states; any of which may harm our business.
See “Part I - Item 1. Business - Regulatory and Compliance Framework” and “Part I - Item 1A. Risk Factors - Risks Related to Our Business and Regulation” for further discussion regarding our regulatory environment.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Liquidity and Capital Resources
Liquidity
Our short-term liquidity needs generally relate to our working capital requirements, including the purchase of loans invested in by the Company. These liquidity needs are generally met through cash generated from the operations of facilitating loan originations, servicing fee revenue, proceeds from the sales of loans (both as whole loan sales and through Structured Program transactions), use of existing cash and cash equivalents, and draws on our credit facilities.
We use our own capital and available credit facilities to purchase loans for future Structured Program transactions, whole loan sales and if we experience a reduction in available investor capital to fund loans on our marketplace. During the year ended December 31, 2019, the Company facilitated $12.3 billion of loans on our marketplace. We used our own capital to purchase $5.3 billion in loans and $7.0 billion in loans were issued that were contemporaneously funded by loan sales and by the issuance of notes and certificates. The Company sold $5.1 billion in loans (of which $4.0 billion was sold through Structured Program transactions and $1.1 billion was sold to whole loan investors). As of December 31, 2019, the fair value of loans invested in by the Company was $766.0 million, of which $551.5 million were pledged as collateral under our credit facilities. Given the member payment dependent structure of the notes, certificates and secured borrowings, principal and interest payments on notes, certificates and secured borrowings are paid only when received from borrowers on the corresponding retained loans, resulting in no material impact to our liquidity.
We may use our cash, cash equivalents and securities available for sale as additional sources of liquidity. Cash, cash equivalents and securities available for sale were $514.7 million (which included $174.8 million of securities pledged as collateral) and $543.4 million (which included $53.6 million of securities pledged as collateral) as of December 31, 2019 and 2018, respectively. Our cash and cash equivalents are primarily held in institutional money market funds, interest-bearing deposit accounts at investment-grade financial institutions, certificates of deposit and commercial paper. Our securities available for sale consist of asset-backed securities related to our Structured Program transactions, corporate debt securities, certificates of deposit, other asset-backed securities, commercial paper, and U.S. agency securities. Changes in the balance of cash and cash equivalents are generally a result of timing related to working capital requirements, purchase or sale of loans and securities available for sale, changes in debt outstanding under our credit facilities, and changes in restricted cash and other investments. Changes in the balance of securities available for sale are generally a result of activity related to our Structured Program transactions. Future cash requirements include certain contingent liabilities, including litigations and ongoing regulatory and government investigations primarily related to outstanding legacy issues. As of December 31, 2019 and 2018, we had $16.0 million and $12.8 million in accrued contingent liabilities, respectively, but actual cash payments may vary if outcomes of legal actions or settlements are different. See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 19. Commitments and Contingencies” for further information.
On February 18, 2020, the Company and Radius entered into a Merger, in a cash and stock transaction valued at $185 million (of which $138.75 million is in cash and $46.25 million is in stock), plus certain purchase price and expense adjustments of up to $22 million. The closing of the Merger is subject to regulatory approval and other customary closing conditions, which the Company anticipates can be completed within 15 months, as well as customary transaction costs. Additionally, in connection with the Share Exchange Agreement, the Company will provide Shanda a one-time cash payment of approximately $50 million. See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 22. Subsequent Events” for additional information.
Our credit facilities and securities sold under repurchase agreements are comprised of secured warehouse credit facilities for personal loans and auto refinance loans (Personal Loan Warehouse Credit Facilities and Auto Loan
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Warehouse Credit Facility), a secured revolving credit facility (Revolving Facility), and repurchase agreements. Personal Loan Warehouse Credit Facilities are used to finance our personal loans on a revolving basis and have a combined borrowing capacity of $750.0 million (which will be reduced to $700.0 million on January 15, 2020), with $373.0 million of debt outstanding secured by $533.6 million of loans at fair value as of December 31, 2019. These Personal Loan Warehouse Credit Facilities have “Commitment Termination Dates” ranging from March 2020 to October 2020, at which point the Company’s ability to borrow additional funds ends. We are working to amend and extend the Commitment Termination Dates of these Personal Loan Warehouse Credit Facilities, or to replace them with substantially similar credit facilities. We are also evaluating additional warehouse facilities to finance our personal loans with existing and new financial institutions. Under the respective agreements, if not amended, extended, or replaced, any outstanding debt on the Commitment Termination Dates would be repaid as an amortizing term loan until the facility’s final maturity dates, ranging from January 2021 to March 2022.
The Auto Loan Warehouse Credit Facility is a term loan used to finance auto refinance loans. The amount borrowed under this Auto Loan Warehouse Credit Facility amortizes over time through regular principal and interest payments collected from the auto refinance loans that serve as collateral. As of December 31, 2019, the Auto Loan Warehouse Credit Facility has an outstanding debt balance of $14.3 million, which matures in June 2021 and is secured by $17.9 million of auto refinance loans at fair value.
The Revolving Facility has a credit limit of $120.0 million, with $60.0 million of debt outstanding as of December 31, 2019, and expires in December 2020.
We have repurchase agreements (with scheduled repurchase dates between February 2020 and December 2026) with counterparties under which we may sell securities (subject to an obligation to repurchase such securities at a specified future date and price) in exchange for cash. As of December 31, 2019, we have an obligation of $140.2 million to repurchase securities with a fair value of $174.8 million.
See “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 14. Debt” for further information.
The Personal Loan and Auto Loan Warehouse Credit Facilities, Revolving Facility and repurchase agreements have interest rates predominately based on LIBOR. The agreements generally include alternative rates to LIBOR. We plan to renew and/or amend the facilities and agreements before the end of 2021, when it has been announced by the United Kingdom’s Financial Conduct Authority that LIBOR is intended to be phased out. In all cases, we expect the alternate rates to be based on prevailing market convention for financing arrangements of an equivalent nature.
We believe, based on our projections, that our cash on hand, securities available for sale, available funds from our Warehouse Facilities and repurchase agreements (subject to amendments and extensions), and cash flow from operations are sufficient to meet our liquidity needs for the next twelve months.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table sets forth certain cash flow information for the periods presented:
(1)
Cash used for operating activities primarily includes the purchase and sale of loans held for sale by the Company.
(2)
Cash provided by loan investing activities includes the purchase of and repayment of loans held for investment. Cash used for note, certificate and secured borrowings financing activities includes the issuance of notes, certificates and secured borrowings to investors and the repayment of those notes, certificates and secured borrowings. These amounts generally correspond to and offset each other.
Operating Activities. Net cash used for operating activities was $(270.6) million, $(639.7) million and $(573.4) million during the years ended December 31, 2019, 2018 and 2017, respectively. Net cash used for loan operating activities relates to proceeds from sales of loans held for sale offset by the purchase of loans held for sale. The timing of the purchases and sales of loans held for sale can vary between periods and can therefore impact the amount of cash provided by or used for operating activities. In periods where we accumulate loans held for sale that are sold in a subsequent period, cash flow from operating activities will be negatively affected. In 2018, cash provided by all other operating activities was primarily impacted by cash paid for class action and regulatory litigation costs.
Investing Activities. Net cash provided by investing activities was $653.8 million, $878.7 million and $998.6 million during the years ended December 31, 2019, 2018 and 2017, respectively. Net cash provided by loan investing activities was primarily driven by purchases of loans held for investment (under our retail program and issuance of notes) and principal receipts on those loans. Net cash provided by all other investing activities was primarily driven by purchases of securities available for sale and purchases of property, equipment and software, offset by proceeds from securities available for sale.
Financing Activities. Net cash used for financing activities was $(540.1) million, $(239.2) million and $(474.3) million during the years ended December 31, 2019, 2018 and 2017, respectively. Net cash used for financing activities was primarily driven by principal payments on and retirements of notes and certificates and principal payments on our credit facilities, offset by proceeds from our credit facilities, the issuance of notes and certificates, and proceeds from securities sold under repurchase agreements.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Capital Resources
Net capital expenditures were $50.7 million, or 7% of total net revenue, $53.0 million, or 8% of total net revenue, and $44.6 million, or 8% of total net revenue, for the years ended December 31, 2019, 2018 and 2017, respectively. Capital expenditures generally consist of internally developed software, leasehold improvements and computer equipment. Capital expenditures in 2020 are expected to be approximately $45.0 million, primarily related to costs associated with the continued development and support of our online lending marketplace platform. In the future, we expect our capital expenditures related to enhancing our platform to increase as we support the growth in our business.
Off-Balance Sheet Arrangements
At both December 31, 2019 and 2018, a total of $5.5 million in standby letters of credit were outstanding related to certain financial covenants required for our leased facilities. To date, no amounts have been drawn against the letters of credit, which renew annually and expire at various dates through July 2026.
In the ordinary course of business, we engage in other activities that are not reflected on our Consolidated Balance Sheets, generally referred to as off-balance sheet arrangements. These activities involve our Structured Program transactions with unconsolidated variable interest entities including Company-sponsored securitizations and Certificate Program transactions. These transactions are used frequently by the Company to provide a source of liquidity to finance our business and to diversify our investor base. The Company retains at least 5% of securities and residual interests from these transactions and enters into a servicing arrangement with the unconsolidated variable interest entity. We are exposed to market risk in the securitization market. We provide additional information regarding transactions with unconsolidated variable interest entities in “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 7. Securitizations and Variable Interest Entities.”
Contingencies
Legal
For a comprehensive discussion of legal proceedings as of December 31, 2019, see “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 19. Commitments and Contingencies.”
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Contractual Obligations
Our principal commitments consist of obligations under our loan funding operation with WebBank and in connection with direct marketing efforts, long-term debt obligations related to our credit facilities and securities sold under repurchase agreements, operating leases for office space and contractual commitments for other support services. The following table summarizes our contractual obligations as of December 31, 2019 and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods:
(1)
Represents loans as of December 31, 2019, the Company could have been required to purchase resulting from direct mail marketing efforts if such loans were not otherwise invested in by investors on the platform. As of the date of this report, no loans remained without investor commitments and the Company was not required to purchase any of these loans.
(2)
Amounts based on contractual maturity dates. The amounts presented in the “3 to 5 Years” and “More than 5 Years” columns above represent the Company’s long-term debt obligations under repurchase agreements, which are paid down based on cash flows received from the underlying securities sold. The Company expects these long-term debt obligations to be satisfied within three years.
(3)
As of December 31, 2019, the Company entered into an additional operating lease which has not yet commenced and is therefore not part of the table above nor included in the lease right-of-use asset and liability. This lease will commence when the Company obtains possession of the underlying asset, which is expected to be on April 1, 2020. The lease term is nine years and has an undiscounted future rent payment of approximately $8.7 million.
(4)
The notes and certificates issued by LendingClub and the LC Trust, respectively, have been excluded from the table above because payments on those liabilities are only required to be made by us if and when we receive the related loan payments from borrowers. Our own liquidity resources are not required to make any contractual payments on the notes or certificates, except in limited instances of proven identity fraud on a related loan.
For a discussion of the Company’s long-term debt obligations as of December 31, 2019, see “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 14. Debt.” For a discussion of the Company’s operating lease obligations, loan purchase obligation, loan repurchase obligations, and purchase commitments as of December 31, 2019, see “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 18. Leases” and “Note 19. Commitments and Contingencies.”
Critical Accounting Estimates
Our significant accounting policies are described in “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 2. Summary of Significant Accounting Policies” of the consolidated financial statements. We consider certain of these policies to be critical accounting policies as they require significant judgments, assumptions and estimates which we believe are critical in understanding and evaluating our reported financial results. These judgments, estimates and assumptions are inherently subjective and actual results may differ from these estimates and assumptions, and the differences could be material.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Fair Value of Loans Held for Investment, Loans Invested in by the Company, Notes and Certificates
We have elected the fair value option for loans held for investment and related notes and certificates, as well as loans invested in by the Company. We primarily use a discounted cash flow model to estimate fair value based on the present value of estimated future cash flows. This model uses both observable and unobservable inputs and reflects our best estimates of the assumptions a market participant would use to calculate fair value. The following describes the primary inputs that require significant judgment:
Expected loss rates - Expected loss rates are estimates of the principal payments that will not be repaid over the life of a loan held for investment, loan invested in by the Company, note or certificate. Expected loss rates are adjusted to reflect the expected principal recoveries on charged-off loans. Expected loss rates are primarily based on the historical performance of the loans facilitated on our platform but also incorporate discretionary adjustments based on our expectations of future credit performance.
Prepayments - Prepayments are estimates of the amount of principal payments that will occur before they are contractually required during the life of a loan held for investment, loan invested in by the Company, note or certificate. Prepayments reduce the projected principal balances, interest payments and expected time loans are outstanding. Prepayment expectations are primarily based on the historical performance of the loans facilitated on our platform but also incorporate discretionary adjustments based on our expectations of future loan performance.
Discount rates - The discount rates applied to the expected cash flows of loans held for investment and related notes and certificates, as well as loans invested in by the Company, reflect our estimates of the rates of return that investors would require when investing in financial instruments with similar risk and return characteristics. Discount rates are based on our estimate of the rate of return investors are likely to receive on new loans facilitated on our platform taking into account the purchasing price. Discount rates for aged loans are adjusted to reflect the market relationship between interest rates and remaining time to maturity.
Fair Value of Asset-backed Securities related to Structured Program Transactions
We classify asset-backed securities related to Structured Program transactions as securities available for sale. These securities are recorded at fair value and unrealized gains and losses are reported, net of taxes, in “Accumulated other comprehensive income (loss)” in the Company’s Consolidated Balance Sheets unless management determines that a security is other-than-temporarily impaired (OTTI).
We estimate fair value based on the price of transactions for similar instruments if available. If market observable prices are not available, we use a discounted cash flow model to estimate fair value based on the present value of estimated future cash flows. This model uses inputs that are both observable and not observable and reflect our best estimates of the assumptions a market participant would use to calculate fair value. The following describes the primary inputs that require significant judgment:
Discount rates - The discount rates for asset-backed securities related to Structured Program transactions reflect our estimates of the rates of return that investors would require when investing in financial instruments with similar risk and return characteristics. The primary source of discount rate observations is the rate of return implied by the sales of asset-backed securities associated with new Structured Program transactions.
We also incorporate estimates of net losses and prepayments in our estimation of asset-backed securities related to Structured Program transactions. These inputs are consistent with the assumptions used in the valuation of loans held for investment and related notes and certificates, as well as loans invested in by the Company.
LENDINGCLUB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Fair Value of Servicing Assets
We record servicing assets at their estimated fair values when we sell loans or we assume or acquire a servicing obligation whereby the underlying loans are not included in our financial statements. The gain or loss on a loan sale is recorded separately in “Gain on sales of loans” in our Consolidated Statements of Operations while the component of the gain or loss that is based on the degree to which the contractual servicing fee is above or below an estimated market servicing rate is recorded as a servicing asset. Servicing assets are reported in “Other assets” on our Consolidated Balance Sheets. Changes in the fair value of servicing assets are reported in “Investor fees” on our Consolidated Statements of Operations in the period in which the changes occur.
We use a discounted cash flow model to estimate the fair values of loan servicing assets. The cash flows in the valuation model represent the difference between the servicing fees charged and an estimated market servicing rate. Since servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimated net expected losses and expected prepayments. The significant assumptions used in valuing our servicing assets are:
Market servicing rates - We consider market servicing rates as those rates which a market participant would require to service the loans that we sell. We estimate these market servicing rates based on our review of available observable market servicing rates.
Discount rates - The discount rates for loan servicing rights reflect our estimates of the rates of return that investors in servicing rights for unsecured consumer credit obligations would require when investing in similar servicing rights. Discount rates for servicing rights on existing loans reflect a risk premium intended to reflect the amount of compensation market participants would require due to the credit and liquidity uncertainty inherent in the instruments’ cash flows.
We also incorporate estimates of net losses and prepayments in our estimation of fair value of servicing assets. These inputs are consistent with the assumptions used in the valuation of loans held for investment and related notes and certificates, as well as loans invested in by the Company.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities in “Accrued expenses and other liabilities” in the Company’s Consolidated Balance Sheets. Associated legal expense is recorded in “Other general and administrative” expense or in “Class action and regulatory litigation expense” for the losses associated with the securities class action lawsuits, as described in “Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 19. Commitments and Contingencies,” in the Company’s Consolidated Statements of Operations. Such liabilities and associated expenses are recorded when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. The Company will also disclose a range of exposure to incremental loss when such amounts are reasonably possible and can be estimated. In estimating the Company’s exposure to loss contingencies, if an amount within the estimated range of loss is the best estimate, that amount will be accrued. However, if there is no amount within the estimated range of loss that is the best estimate, the Company will accrue the minimum amount within the range, and disclose the amount up to the high end of the range as an exposure to incremental loss, if such amount is considered reasonably possible. Such estimates are based on the best information available at the time. As additional information becomes available, we reassess the potential liability and record an adjustment to our estimate in the period in which the adjustment is probable and an amount or range can be reasonably estimated. The determination of an expected contingent liability and associated litigation expense requires the Company to make assumptions related to the outcome of these matters. Due to the inherent uncertainties of loss contingencies, our estimates may be different than the actual outcomes.
LENDINGCLUB CORPORATION
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact our financial position due to adverse changes in market discount rates and servicing rates, interest rates and credit performance of loans. We are exposed to market risk directly through loans and securities held on our balance sheet, access to the securitization markets, investor demand for our loans, current and future debt under our credit facilities, and our servicing assets.
Market Rate Sensitivity
Market rate sensitivity refers to the risk of loss to future earnings, values or future cash flows that may result from changes in market discount rates and servicing rates.
Loans Invested in by the Company. As of December 31, 2019 and 2018, we were exposed to market rate risk on $766.0 million and $842.6 million of loans invested in by the Company at fair value, respectively, which have fixed interest rates. The fair values of loans are estimated using a discounted cash flow methodology, where the discount rate represents an estimate of the required rate of return by market participants. The discount rates for our loans may change due to expected loan performance or changes in the expected returns of similar financial instruments available in the market. Any realized or unrealized losses from market rate changes on loans invested in by the Company are recorded in earnings.
The Company’s continued facilitation of loan originations depends on an active liquid market, third-party investor demand for loans and successful Structured Program transactions and loan sales. The Company could respond to disruptions in ongoing investor demand due to changes in yield expectations, availability and yield of alternative investments, and liquidity in capital markets with reductions in origination facilitations or sales of loans at discounts, thereby negatively impacting revenue.
The following table presents the impact to the fair value of loans invested in by the Company due to a hypothetical change in discount rates as of December 31, 2019 and 2018:
Servicing Assets. As of December 31, 2019 and 2018, we were exposed to market servicing rate risk on $89.7 million and $64.0 million of servicing assets, respectively. Our selection of the most representative market servicing rates is inherently judgmental. The following table presents the impact to the fair value of servicing assets due to a hypothetical change in the market servicing rate assumption as of December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Interest Rate Sensitivity
The fair values of certain of our assets and liabilities are sensitive to changes in interest rates. Fixed rates may adversely affect market value due to a rise in interest rates, while floating rates may produce less income than expected if interest rates fall. The impact of changes in interest rates would be reduced by the fact that increases or decreases in fair values of assets would be partially offset by corresponding changes in fair values of liabilities.
Loans Invested in by the Company. As of December 31, 2019 and 2018, we were exposed to interest rate risk on $766.0 million and $842.6 million of loans invested in by the Company at fair value, respectively, which have fixed interest rates. Any realized or unrealized losses from interest rate changes are recorded in earnings. The following table presents the impact to the fair value of loans invested in by the Company due to a hypothetical change in interest rates as of December 31, 2019 and 2018:
Securities Available for Sale. As of December 31, 2019 and 2018, we were exposed to interest rate risk on $270.9 million and $170.5 million of securities available for sale, respectively, including $220.1 million and $116.8 million of asset-backed securities related to Structured Program transactions and $50.8 million and $53.7 million of corporate debt, certificates of deposit, other asset-backed securities, commercial paper and other securities, respectively. To manage this risk, we limit and monitor maturities, credit ratings, performance of loans underlying Structured Program transactions and concentrations within the investment portfolio. Any unrealized gains or losses resulting from such interest rate changes would only be recorded in earnings if we sold the securities prior to maturity or if the securities were considered other-than-temporarily impaired.
The following table presents the impact to the fair value of securities available for sale due to a hypothetical change in interest rates as of December 31, 2019 and 2018:
Credit Facilities and Securities Sold Under Repurchase Agreements. As of December 31, 2019 and 2018, we were exposed to interest rate risk on $387.3 million and $306.8 million of funding under the Personal Loan and Auto Loan Warehouse Credit Facilities, $60.0 million and $95.0 million of funding under the Revolving Facility, and $140.2 million and $57.0 million of funding under our repurchase agreements, respectively. Future funding activities may increase our exposure to interest rate risk, as the interest rates payable on such funding are generally tied to LIBOR.
LENDINGCLUB CORPORATION
The following table presents the impact to the annualized interest expense related to our credit facilities and securities sold under repurchase agreements due to a hypothetical change in the one-month LIBOR rate as of December 31, 2019 and 2018:
Cash and Cash Equivalents. As of December 31, 2019 and 2018, we had cash and cash equivalents of $243.8 million and $373.0 million, respectively. These amounts were held primarily in interest-bearing deposits at investment grade financial institutions, institutional money market funds, certificates of deposit, and commercial paper, which are short-term. Due to their short-term nature, we do not believe we have material exposure to changes in the fair value of these liquid investments as a result of changes in interest rates.
Credit Performance Sensitivity
Credit performance sensitivity refers to the risk of loss arising from default when borrowers are unable or unwilling to meet their financial obligations. We invest in loans and asset-backed securities (including residual interests) related to Structured Program transactions. The performance of these loans and asset-backed securities is dependent on the credit performance of loans facilitated by us. To manage this risk, we monitor borrower payment performance and how it may impact the valuation of our investments. The valuation of these investments is based on a discounted cash flow analysis and includes Level 3 assumptions. Any unrealized losses on asset-backed securities (including residual interests) are evaluated for other-than-temporary impairment and any impairment is recorded in earnings. All other unrealized gains and losses are recorded in the Company’s Consolidated Statements of Comprehensive Income (Loss).
Loans Invested in by the Company. As of December 31, 2019 and 2018, we were exposed to credit performance risk on $766.0 million and $842.6 million of loans invested in by the Company at fair value, respectively, which have fixed interest rates. The following table presents the impact to the fair value of loans invested in by the Company due to a hypothetical change in credit loss rates as of December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Asset-backed Securities Related to Structured Program Transactions. As of December 31, 2019 and 2018, we were exposed to credit performance risk on $220.1 million and $116.8 million of asset-backed securities related to Structured Program transactions, respectively, including securities pledged as collateral. The following table presents the impact to the fair value of asset-backed securities related to Structured Program transactions due to a hypothetical change in credit loss rates as of December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of LendingClub Corporation:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of LendingClub Corporation and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 19, 2020, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Valuation of Level 3 Financial Assets and Unobservable Inputs Therein
-
Securities Available for Sale - See Note 5. Securities Available for Sale
-
Loans Held for Investment by the Company at Fair Value - See Note 6. Loans Held for Investment, Loans Held for Sale, Notes, Certificates and Secured Borrowings
-
Loans Held for Sale by the Company at Fair Value - See Note 6. Loans Held for Investment, Loans Held for Sale, Notes, Certificates and Secured Borrowings
-
Fair Value of Assets and Liabilities - See Note 8. Fair Value of Assets and Liabilities
Critical Audit Matter Description
The Company holds assets including loans held for sale by the Company, loans held for investment by the Company, asset-backed securities and asset-backed subordinated securities held in the Company’s securities available for sale portfolio whose fair values are estimated by discounted cash flow models. These Level 3 assets have inputs that are unobservable in the market but reflective of the Company’s assumptions about what market participants would use to price the asset. Their values are estimated using complex models that include assumptions and estimates, some of which are unobservable inputs that require significant judgment.
Auditing the models and unobservable inputs used by management to estimate the fair value of these Level 3 assets involves subjective and complex judgments.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the models and unobservable inputs used by management to estimate the fair value of these Level 3 assets included the following key procedures:
•
We tested the effectiveness of controls, including those related to model validation, price calibration, discount rate, loss curves, and prepayment curves.
•
We evaluated management’s ability to accurately estimate fair value by comparing management’s historical price calibration and projected prepayment and loss curves to actual results.
•
We compared management’s assumptions to external sources, including the Company’s comparable market transaction data, where available.
•
With the assistance of our fair value specialists, we developed independent estimates of fair values and compared our estimates to the Company’s estimates.
Valuation and Disclosure of Litigation and Regulatory Matters
-
Commitments and Contingencies - See Note 19. Commitments and Contingencies
Critical Audit Matter Description
The accrued contingent liability and associated litigation expense related to certain ongoing litigation and regulatory matters are estimated, recorded and disclosed based on the Company’s expectations regarding the probability and magnitude of any expected losses. These estimates are refined as information becomes available over the course of the associated matters. The determination of an expected contingent liability and associated litigation expense requires management to make assumptions related to the outcome of these matters. Due to the inherent uncertainty involved in the assessment of the outcome, the actual loss may be different than the Company’s estimates of expected loss. The Company’s accrued contingent liability as of December 31, 2019 was $16.0 million, with contingent liability expense for the year ended December 31, 2019 of $3.3 million.
Auditing the probability of an unfavorable outcome and the estimate of the associated exposure involves subjective and complex judgment and careful evaluation of the facts in coordination with the Company’s legal counsel as information becomes available.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to assessing the probability of outcome related to these matters and estimates of reasonably possible loss or range of loss included the following key procedures:
•
We tested the effectiveness of controls over the valuation of contingent liabilities related to outstanding and anticipated litigation and regulatory matters, including the evaluation of whether such exposures are probable or reasonably possible.
•
We tested the effectiveness of controls over the presentation and disclosure of litigation and regulatory matters.
•
We inspected board and committee meeting materials and minutes and attended meetings with General Counsel, Executives and the Audit Committee for updates on litigation and regulatory matters.
•
We sent independent third-party confirmations to external counsel and ascertained completeness of the litigation matters brought to our attention by internal counsel.
•
We evaluated the reasonableness of management’s estimates of loss contingencies by holding meetings with management and the Company’s internal counsel, reviewing the Company’s responses to regulators where applicable, and reviewing correspondence between the Company’s attorneys and the plaintiffs’ attorneys where applicable.
•
We evaluated management’s ability to estimate loss contingencies by comparing actual settlements for matters existing at the end of prior periods with their historical forecasts.
•
We obtained a legal letter from the Company’s internal counsel detailing the status of all material current litigation and regulatory matters commensurate with the date of our reports.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
February 19, 2020
We have served as the Company’s auditor since 2013.
LENDINGCLUB CORPORATION
Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Amounts)
(1)
Includes amounts in consolidated variable interest entities (VIEs) presented separately in the table below.
(2)
The Company adopted ASU 2016-02, Leases, as of January 1, 2019, and has elected not to restate comparative periods presented in the consolidated financial statements. For additional information, see “Notes to Consolidated Financial Statements - Note 2. Summary of Significant Accounting Policies” and “Notes to Consolidated Financial Statements - Note 18. Leases.”
(3)
Prior period share information and balances have been retroactively adjusted to reflect a reverse stock split. See “Notes to Consolidated Financial Statements - Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Amounts)
The following table presents the assets and liabilities of consolidated VIEs, which are included in the Consolidated Balance Sheets above. The assets in the table below may only be used to settle obligations of consolidated VIEs and are in excess of those obligations. Additionally, the assets and liabilities in the table below include third-party assets and liabilities of consolidated VIEs only and exclude intercompany balances that eliminate in consolidation.
See Notes to Consolidated Financial Statements.
LENDINGCLUB CORPORATION
Consolidated Statements of Operations
(In Thousands, Except Share and Per Share Amounts)
(1)
See “Notes to Consolidated Financial Statements - Note 1. Basis of Presentation” for additional information.
(2)
All share and per share information has been retroactively adjusted to reflect a reverse stock split. See “Notes to Consolidated Financial Statements - Note 4. Net Loss Per Share” for additional information.
See Notes to Consolidated Financial Statements.
LENDINGCLUB CORPORATION
Consolidated Statements of Comprehensive Income (Loss)
(In Thousands)
See Notes to Consolidated Financial Statements.
LENDINGCLUB CORPORATION
Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands, Except Share Data)
(1)
All share information and balances have been retroactively adjusted to reflect a reverse stock split. See “Notes to Consolidated Financial Statements - Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands, Except Share Data)
(2)
Includes shares purchased by the Company in lieu of issuing fractional shares in connection with a 1-for-5 reverse stock split effective on July 5, 2019 and shares that were transferred to the Company to satisfy payment of all or a portion of the exercise price in connection with the exercise of stock options.
See Notes to Consolidated Financial Statements.
LENDINGCLUB CORPORATION
Consolidated Statements of Cash Flows
(in Thousands)
LENDINGCLUB CORPORATION
Consolidated Statements of Cash Flows
(in Thousands)
(1)
Change in payable to investors was previously presented as cash flows from financing activities. Prior period amounts have been reclassified to conform to the current period presentation.
The following presents cash, cash equivalents and restricted cash by category within the Consolidated Balance Sheets:
See Notes to Consolidated Financial Statements.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
1. Basis of Presentation
LendingClub Corporation (LendingClub) operates an online lending marketplace platform that connects borrowers and investors. Various wholly-owned subsidiaries of LendingClub have been established to enter into borrowing agreements with certain lenders for secured credit facilities. Additionally, LendingClub has established various entities to facilitate loan sale transactions, including sponsoring asset-backed securitization transactions and Certificate Program transactions (collectively referred to as Structured Program transactions), where certain accredited investors and qualified institutional buyers have the opportunity to invest in senior and subordinated securities backed by a pool of unsecured personal whole loans. Certificate Program transactions include CLUB Certificate and Levered Certificate transactions. LC Trust I (the LC Trust) is an independent Delaware business trust that acquires loans from LendingClub and holds them for the sole benefit of certain investors that have purchased trust certificates issued by the LC Trust that are related to specific underlying loans for the benefit of the investor. Springstone Financial, LLC (Springstone), is a wholly-owned subsidiary of LendingClub that facilitates education and patient finance loans originated by third-party issuing banks.
The accompanying consolidated financial statements include LendingClub, its subsidiaries (collectively referred to as the Company, we, or us) and consolidated variable interest entities (VIEs). Noncontrolling interests are reported as a separate component of consolidated equity from the equity attributable to LendingClub’s stockholders for all periods presented. All intercompany balances and transactions have been eliminated. These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) for financial information and, in the opinion of management, contain all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the results and financial position for the periods presented. These accounting principles require management to make certain estimates and assumptions that affect the amounts in the accompanying financial statements. These estimates and assumptions are inherently subjective in nature and actual results may differ from these estimates and assumptions, and the differences could be material. Certain prior-period amounts have been reclassified to conform to the current period presentation.
A 1-for-5 reverse stock split of the Company’s common stock became effective on July 5, 2019. As a result, prior period share and per share amounts presented in the accompanying consolidated financial statements and these related notes were retroactively adjusted accordingly. See “Note 4. Net Loss Per Share” for additional information.
In the fourth quarter of 2019, the Company presented operating lease assets and operating lease liabilities separately from “Other assets” and “Accrued expenses and other liabilities,” respectively, on its Consolidated Balance Sheets. In the first quarter of 2019, the Company presented a new sub-total caption called “Net investor revenue” on its Condensed Consolidated Statements of Operations and also reordered the presentation of certain of its existing captions. The Company believes this new presentation allows shareholders a view of net investor revenue and our capital markets activity, which includes net interest income and fair value adjustments of loans and securities available for sale, gain on sales of loans invested in by the Company and investor fees from servicing of loans. These changes in presentation had no impact on prior period amounts presented.
The Company presents loans under a number of different captions to align the assets to their associated liabilities, if any. “Loans held for investment at fair value” are loans which are related to the Company’s retail notes, certificates and secured borrowings program. The Company is not exposed to market risk, interest rate risk or credit risk on these loans and all loan cash flows flow directly to the retail note, certificate and secured borrowing owners. The associated liability for this loan category is included in the caption “Notes, certificates and secured borrowings at fair value.” Loans included in “Loans held for investment by the Company at fair value” and “Loans held for sale by the Company at fair value” are loans which the Company has purchased and from which the Company earns interest income and records net fair value adjustments in earnings for changes in the valuation of loans.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
2. Summary of Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents include the Company’s unrestricted deposits with investment-grade financial institutions, institutional money market funds, certificates of deposit, and commercial paper. The Company considers all highly liquid investments with stated maturity dates of three months or less from the date of purchase to be cash equivalents.
Restricted Cash
Restricted cash consists primarily of bank deposits and money market funds that are: (i) pledged as security for transactions processed on or related to LendingClub’s platform or activities by certain investors; and (ii) received from the borrower and applied to the loan, but not yet distributed to the investor’s internal platform account or sent to their external account.
Investor cash balances (excluding transactions-in-process) are held in segregated bank or custodial accounts and are not commingled with the Company’s monies or held on the Company’s Consolidated Balance Sheets.
Securities Available for Sale
Debt securities that the Company might not hold until maturity are classified as securities available for sale. In structured program transactions that meet the applicable criteria to be accounted for as a sale, the Company retains certain asset-backed securities including subordinated residual interests and CLUB Certificates, which are classified as securities available for sale. Securities available for sale are recorded at fair value and unrealized gains and losses are reported, net of taxes, in “Accumulated other comprehensive income (loss)” included in Equity in the Company’s Consolidated Balance Sheets unless management determines that a security is other-than-temporarily impaired (OTTI). Realized gains and losses from sales of securities available for sale are included in “Net fair value adjustments” in the Company’s Consolidated Statements of Operations.
Management evaluates whether debt securities available for sale with unrealized losses are OTTI on a quarterly basis. If the Company intends to sell the security, or if it is more likely than not that it will be required to sell the security before recovery, an OTTI is recognized in earnings equal to the entire difference between the amortized cost basis and fair value of the debt security. However, even if the Company does not expect to sell a debt security it must evaluate the expected cash flows to be received and determine if a credit loss exists. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in earnings and amounts related to factors other than credit losses are recorded in other comprehensive income. Impairment charges are recorded in “Net fair value adjustments” in the Company’s Consolidated Statements of Operations.
Loans Held for Investment by the Company and Loans Held for Sale by the Company
The Company has elected the fair value option for loans held for investment by the Company and loans held for sale by the Company. Changes in the fair value of loans held by the Company are recorded in “Net fair value adjustments” in the Consolidated Statements of Operations in the period of the fair value changes. The Company places loans held by the Company on non-accrual status at 90 days past due. Accrued interest income on loans held by the Company is calculated based on the contractual interest rate of the loan held by the Company and recorded as interest income as earned. When a loan held by the Company is placed on non-accrual status, the Company stops accruing interest and reverses all accrued but unpaid interest as of such date. The Company charges-off loans held by the Company no later than 120 days past due.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Loans Held for Investment and Related Notes and Certificates
The Company has elected the fair value option for loans held for investment and related notes and certificates. Due to the payment dependent feature of the notes and certificates, changes in the fair value of the notes and certificates are offset by changes in the fair values of related loans, resulting in no net effect on the Company’s earnings. The Company places loans held for investment on non-accrual status at 90 days past due. Interest receivable on loans held for investment and accrued interest payable on notes and certificates are reduced when the corresponding loan held for investment is placed on non-accrual status due to the payment dependent nature of the loans held for investment and related notes and certificates. The Company charges-off loans held for investment and related notes and certificates no later than 120 days past due.
Servicing Assets
The Company records servicing assets at their estimated fair values when it sells loans or when the Company assumes or acquires a servicing obligation whereby the underlying loans are not included in its financial statements. The gain or loss on a loan sale is recorded separately in “Gain on sales of loans” in the Company’s Consolidated Statements of Operations while the component of the gain or loss that is based on the degree to which the contractual servicing fee is above or below an estimated market servicing rate is recorded as a servicing asset. Servicing assets are reported in “Other assets” on the Company’s Consolidated Balance Sheets. Changes in the fair value of servicing assets are reported in “Investor fees” in the Company’s Consolidated Statements of Operations in the period in which the changes occur.
Fair Value of Assets and Liabilities
Fair value is the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date (an exit price). The Company uses fair value measurements in its fair value disclosures and to record securities available for sale, loans held for investment and loans held for sale, notes and certificates, and servicing assets and liabilities at fair value on a recurring basis.
The fair value hierarchy includes a three-level classification, which is based on whether the inputs to the valuation methodology used for measurement are observable:
Level 1
-
Quoted market prices in active markets for identical assets or liabilities.
Level 2
-
Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly.
Level 3
-
Unobservable inputs.
When developing fair value measurements, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. However, for certain instruments the Company must utilize unobservable inputs in determining fair value due to the lack of observable inputs in the market, which requires greater judgment in measuring fair value. In instances where there is limited or no observable market data, fair value measurements for assets and liabilities are based primarily upon the Company’s own estimates, and the measurements reflect information and assumptions that management believes a market participant would use in pricing the asset or liability.
Loans held for investment, loans held for sale and related notes, certificates and secured borrowings, are measured at estimated fair value using a discounted cash flow model. The fair valuation methodology considers projected prepayments, underwriting changes and the historical actual defaults, losses and recoveries on the Company’s loans to project future losses and net cash flows on loans. Net cash flows on loans are discounted using an estimate of market rates of return.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Loan servicing assets are measured at estimated fair value using a discounted cash flow model. The cash flows in the valuation model represent the difference between the contractual servicing fees charged to investors and an estimated market servicing rate. Since contractual servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimates of net expected losses and prepayments.
The Company uses prices obtained from third-party pricing services to measure the fair value of securities available for sale when available. The Company compares the prices obtained from its primary independent pricing service to the prices obtained from the additional independent pricing services to determine if the price obtained from the primary independent pricing service is reasonable. When third-party pricing services are not available for a security, such as subordinated residual certificates and CLUB Certificates, the Company measures the fair value of these securities using a discounted cash flow model incorporating inputs consistent with loans held for investment, loans held for sale and related notes, certificates, secured borrowings, and payable to securitization note and certificate holders.
Property, Equipment and Software, net
Property, equipment and software are carried at cost less accumulated depreciation and amortization. The Company uses the straight-line method of depreciation and amortization. Estimated useful lives range from three years to five years for furniture and fixtures, computer equipment, and software. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life.
Internally developed software is capitalized when preliminary development efforts are successfully completed and it is probable that the project will be completed, and the software will be used as intended. Capitalized costs consist of salaries and compensation costs for employees, fees paid to third-party consultants who are directly involved in development efforts, and costs incurred for upgrades and enhancements to add functionality of the software. Other costs are expensed as incurred.
The Company evaluates impairments of its property, equipment and software whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If the asset is not recoverable, measurement of an impairment loss is based on the fair value of the asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its estimated fair value.
Goodwill and Intangible Assets
Goodwill represents the fair value of an acquired business in excess of the aggregate fair value of the identified net assets acquired. Goodwill is not amortized but is tested for impairment annually or more frequently whenever events or circumstances indicate that it is more likely than not that the estimated fair value of a reporting unit is below its carrying value. The Company’s annual impairment testing date is April 1. Impairment exists whenever the carrying value of goodwill exceeds its estimated fair value. Adverse changes in impairment indicators such as loss of key personnel, lower than forecast financial performance, increased competition, increased regulatory oversight, or unplanned changes in operations could result in impairment.
The Company can elect to qualitatively assess goodwill for impairment if it is more likely than not that the estimated fair value of a reporting unit (generally defined as an operating segment or one level below an operating segment for which financial information is available and reviewed regularly by management) exceeds its carrying value. A qualitative assessment may consider macroeconomic and other industry-specific factors, such as trends in short-term and long-term interest rates and the ability to access capital or company-specific factors, such as market capitalization in excess of net assets, trends in revenue-generating activities and merger or acquisition activity.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
If the Company does not qualitatively assess goodwill it compares a reporting unit’s estimated fair value to its carrying value. The Company estimates the fair value of a reporting unit using either an income approach (discounted cash flow model) or the income approach corroborated by a market approach. Goodwill impairment loss is measured as the amount by which the carrying amount of a reporting unit exceeds its fair value.
When applying the income approach, the Company uses a discounted cash flow model, which requires the estimation of cash flows and an appropriate discount rate. The Company projects cash flows expected to be generated by a reporting unit inclusive of an estimated terminal value. The discount rate assumption contemplates a weighted-average cost of capital based on both market observable and company-specific factors. The discount rate is risk-adjusted to include any premiums related to equity price volatility, size, and projected capital structure of publicly traded companies in similar lines of business.
The Company relies on several assumptions when estimating the fair value of a reporting unit using the discounted cash flow method. These assumptions include the current discount rate discussed above, as well as transaction fee revenue based on projected loan origination growth and revenue growth, projected operating expenses and Contribution Margin, direct and allocated general and administrative and technology expenses, capital expenditures and income taxes. The Company believes these assumptions to be representative of assumptions that a market participant would use in valuing a reporting unit, but these assumptions involve the use of estimates and judgments, particularly related to future cash flows, which are inherently uncertain. There can be no assurances that estimates and assumptions made for purposes of goodwill impairment testing will prove accurate predictions of the future.
The market approach estimates the fair value of a reporting unit based on certain market value multiples of publicly traded companies in similar lines of business, such as total enterprise value to revenue, or to EBITDA. Under the market approach, the Company also considers fair value implied from any relevant and comparable market transactions.
Goodwill impairment loss is measured as the amount by which the carrying amount of a reporting unit exceeds its fair value. See “Note 11. Intangible Assets and Goodwill” for additional information.
Intangible assets are amortized over their useful lives in a manner that best reflects their economic benefit, which may include straight-line or accelerated methods of amortization. Intangible assets are reviewed for impairment quarterly and whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Company does not have indefinite-lived intangible assets.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities in “Accrued expenses and other liabilities” in the Company’s Consolidated Balance Sheets. Associated legal expense is recorded in “Other general and administrative” expense or in “Class action and regulatory litigation expense” for the losses associated with the securities class action lawsuits, as described in “Note 19. Commitments and Contingencies,” in the Company’s Consolidated Statements of Operations. Such liabilities and associated expenses are recorded when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. The Company will also disclose a range of exposure to incremental loss when such amounts are reasonably possible and can be estimated. In estimating the Company’s exposure to loss contingencies, if an amount within the estimated range of loss is the best estimate, that amount will be accrued. However, if there is no amount within the estimated range of loss that is the best estimate, the Company will accrue the minimum amount within the range, and disclose the amount up to the high end of the range as an exposure to incremental loss, if such amount is considered reasonably possible. Such estimates are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability and records an adjustment to its estimate in the period in which the adjustment is probable and an amount or range can be reasonably estimated. The determination of an expected contingent liability and associated litigation expense requires the
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Company to make assumptions related to the outcome of these matters. Due to the inherent uncertainties of loss contingencies, the Company’s estimates may be different than the actual outcomes. Legal fees, including legal fees associated with loss contingencies, are recognized as incurred and included in “Other general and administrative” expense in the Company’s Consolidated Statements of Operations.
Insurance Recoveries
Insurance recoveries of all or a portion of incurred losses are recognized when realization of the claim for recovery is probable. Any insurance recoveries in excess of losses incurred are accounted for as a gain contingency. Insurance recoveries are recorded in “Other assets” in the Company’s Consolidated Balance Sheets. Insurance recoveries associated with the reimbursement of legal expenses arising from loss contingencies and legal fees are recorded as a contra-expense in “Other general and administrative” expense or, if such recoveries are associated with the securities class action lawsuits, as a contra-expense in “Class action and regulatory litigation expense” in the Company’s Consolidated Statements of Operations.
Revenue Recognition
Transaction Fees: The Company has a single performance obligation to provide customers access to the Company’s platform. Transaction fees are considered revenue from contracts with customers, including issuing banks and education and patient service providers. The Company recognizes transaction fee revenue each time a loan is facilitated by the Company, who provides loan application processing and loan facilitation services, resulting in a loan issued by the customers.
Transaction fees are based on the initial principal amount of the loans facilitated by the Company and paid by the issuing banks and education and patient service providers each time a loan is issued by the issuing banks. Transaction fees to which the Company expects to be entitled are variable consideration because loan volume originated over the contractual term is not known at the contract’s inception. The transaction fee is determined each time a loan is issued based on that loan’s initial principal amount.
The Company pays WebBank a loan trailing fee to give WebBank an ongoing financial interest in the performance of the loans it originates and sells to the Company. The Loan Trailing Fee is paid over time based on the amount and timing of principal and interest payments made by borrowers of the underlying loans. The Loan Trailing Fee is consideration payable to WebBank and the loan trailing fee liability is recorded at fair value. Additionally, the Company assumes the issuing bank’s obligation under Utah law to refund the pro-rated amount of the transaction fee in excess of 5% in the event the borrower prepays the loan in full before maturity. Both the loan trailing fees and transaction fee refunds are recorded as a reduction of transaction fee revenue in the Company’s Consolidated Statements of Operations and are included in “Accrued expenses and other liabilities” on the Company’s Consolidated Balance Sheets.
Other Revenue: Other revenue primarily consists of referral fee revenue and sublease revenue from our sublet office space in San Francisco, California. The Company is entitled to receive referral fees from third-party companies when customers referred by the Company consider or purchase products or services from such third-party companies. Referral contracts contain a single performance obligation. The Company recognizes referral fees for each distinct instance when the criteria for receiving the referral fee has been satisfied. Sublease revenue is recognized on a straight-line basis over the term of the lease.
Stock-based Compensation
Stock-based compensation includes expense associated with restricted stock units (RSUs) and performance-based restricted stock units (PBRSUs), stock options, and the Company’s employee stock purchase plan (ESPP), as well as expense associated with stock issued related to acquisitions. Stock-based compensation expense is based on the
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
grant date fair value of the award. The cost is generally recognized over the vesting period on a straight-line basis. Forfeitures are recognized as incurred.
Income Taxes
The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company recognizes deferred tax assets to the extent that it believes these assets are more likely than not to be realized. In making such a determination, the Company considers the available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts that are more likely than not expected to be realized. If the Company determines that it is able to realize its deferred tax assets in the future in excess of the net recorded amount, the Company decreases the deferred tax asset valuation allowance, which reduces the provision for income taxes.
Uncertain tax positions are recognized only when we believe it is more likely than not that the tax position will be upheld on examination by the taxing authorities based on the merits of the position. The Company recognizes interest and penalties, if any, related to uncertain tax positions in “Income tax expense (benefit)” in the Consolidated Statements of Operations.
Net Income (Loss) Per Share
Basic net income (loss) per share (Basic EPS) attributable to common stockholders is computed by dividing net income (loss) attributable to LendingClub by the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per share (Diluted EPS) is computed by dividing net income (loss) attributable to LendingClub by the weighted-average number of shares of common stock outstanding during the period, adjusted for the effects of dilutive shares of common stock, which include incremental shares issued for RSUs, PBRSUs, and stock options. PBRSUs are included in dilutive shares to the extent the pre-established targets have been or are estimated to be satisfied as of the reporting date. The dilutive potential common shares are computed using the treasury stock method. The effects of outstanding RSUs, PBRSUs, and stock options are excluded from the computation of Diluted EPS in periods in which the effect would be antidilutive.
Consolidation of Variable Interest Entities
A variable interest entity (VIE) is a legal entity that has either a total equity investment that is insufficient to finance its activities without additional subordinated financial support or whose equity investors lack the characteristics of a controlling financial interest. The Company’s variable interest arises from contractual, ownership or other monetary interests in the entity, which change with fluctuations in the fair value of the entity’s net assets. A VIE is consolidated by its primary beneficiary, the party that has both the power to direct the activities that most significantly impact the VIE’s economic performance, and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The Company consolidates a VIE when it is deemed to be the primary beneficiary. The Company assesses whether or not it is the primary beneficiary of a VIE on an ongoing basis.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Transfers of Financial Assets
The Company accounts for transfers of financial assets as sales when it has surrendered control over the transferred assets. Control is generally considered to have been surrendered when the transferred assets have been legally isolated from the Company, the transferee has the right to pledge or exchange the assets without any significant constraints, and the Company has not entered into a repurchase agreement, does not hold unconditional call options and has not written put options on the transferred assets. In assessing whether control has been surrendered, the Company considers whether the transferee would be a consolidated affiliate and the impact of all arrangements or agreements made contemporaneously with, or in contemplation of the transfer, even if they were not entered into at the time of transfer. The Company measures gain or loss on sale of financial assets as the net proceeds received on the sale less the carrying amount of the loans sold. The net proceeds of the sale represent the fair value of any assets obtained or liabilities incurred as part of the transaction, including, but not limited to servicing assets, retained securities, and recourse obligations.
Transfers of financial assets that do not qualify for sale accounting are reported as secured borrowings. Accordingly, the related assets remain on the Company’s Consolidated Balance Sheets and continue to be reported and accounted for as if the transfer had not occurred. Cash proceeds from these transfers are reported as liabilities, with related interest expense recognized over the life of the related assets.
Adoption of New Accounting Standards
The Company adopted the following accounting standards during the year ended December 31, 2019:
Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), requires lessees to record on their balance sheets a lease liability for the obligation to make lease payments and a right-of-use (ROU) asset for the right to use the underlying asset for the lease term. The Company adopted Topic 842 as of January 1, 2019 and has elected not to restate comparative periods presented in the consolidated financial statements. The Company has chosen not to elect the practical expedients permitted under the transition guidance within the new standard, which among other things, permits entities to carry forward their historical lease identification. The Company has made an accounting policy election to not recognize lease liabilities and ROU assets for short-term leases, which are leases with initial terms of 12 months or less and for which there is not a purchase option that is reasonably certain to be exercised. All leases within the Company’s portfolio are classified as operating leases.
Adoption of Topic 842 had an impact on the Company’s Consolidated Balance Sheets but did not have an impact on the Company’s Consolidated Statements of Operations or Consolidated Statements of Cash Flows. The most significant impact was the recognition of ROU assets and lease liabilities of $95.2 million and $110.1 million at the time of adoption, respectively, with no cumulative effect in retained earnings. The difference between the ROU assets and lease liabilities is the unamortized balance of deferred rent, which prior to January 1, 2019, was included as a separate liability within Accrued expenses and other liabilities. The operating lease expenses are included in Other general and administrative expense and sublease income is recorded in Other revenue in the Company’s Consolidated Statements of Operations. The Company included the disclosures required by ASU 2016-02 in “Note 18. Leases.”
In July 2019, the Financial Accounting Standards Board (FASB) issued ASU 2019-07, Codification Updates to SEC Sections. The ASU clarifies and/or improves the disclosure and presentation requirements of a variety of codification topics by aligning them with the Securities and Exchange Commission’s regulations, thereby eliminating redundancies and making the codification easier to apply. This ASU became effective upon issuance and did not have a significant impact on the Company’s consolidated financial statements and related disclosures.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
New Accounting Standards Not Yet Adopted
In June 2016, the FASB amended guidance related to impairment of financial instruments as part of ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which became effective on January 1, 2020. For loans accounted for at amortized cost, the guidance replaces the incurred loss impairment methodology with an expected credit loss model for which a company recognizes an allowance based on the estimate of expected credit loss. Because the Company has elected the fair value option for loans and loans accounted for at fair value through net income are outside the scope of Topic 326, the Company expects no impact on its loan portfolios upon adoption. For accrued interest receivable related to such loans, the Company has made an accounting policy election not to measure an allowance for credit losses on accrued interest receivable as the Company writes off uncollectible accrued interest receivable in a timely manner. Uncollectible accrued interest receivable amounts are written off to interest income.
For debt securities available for sale, Topic 326 requires recognition of expected credit losses by recognizing an allowance for credit losses when the fair value of the security is below amortized cost and the recognition of this allowance is limited to the difference between the security’s amortized cost basis and fair value. The standard eliminates the existing guidance for purchased credit impaired assets but requires an allowance for purchased financial assets with more than insignificant deterioration since origination. The measurement guidance for purchased financial assets with credit deterioration also applies to beneficial interests classified as available for sale where there is a significant difference between contractual and expected cash flows at the date of recognition.
Upon adoption, the amendments in Topic 326 will be recognized through a cumulative-effect adjustment to retained earnings, except for debt securities with prior other-than-temporary impairment whereby Topic 326 is applied prospectively. The Company made substantial progress in line with the established project plan and determined there was not a transition adjustment upon adoption of the standard on January 1, 2020. The targeted amendments to the debt securities available for sale impairment model do not have a material impact on the Company’s financial position, results of operations, cash flows, and disclosures for transition securities; the Company is still evaluating the impact for new securities acquired on and after January 1, 2020.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements on fair value measurements by removing, modifying, or adding certain disclosures. The ASU eliminates such disclosures as the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and valuation processes for Level 3 fair value measurements. The ASU adds new disclosure requirements for Level 3 measurements. The new guidance became effective on January 1, 2020. The Company is finalizing the impact this ASU will have on its disclosures and does not expect such adoption to have a material impact.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software - (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which requires a customer in a hosting arrangement that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. The standard became effective on January 1, 2020 and the Company adopted the standard using the prospective approach. The Company has reviewed existing cloud computing arrangements and determined which ones are service contracts. Implementation costs that are not from internal developers related to service contracts that satisfy the criteria for capitalization under ASC 350-40 will be presented with “Other assets” on the Company’s Consolidated Balance Sheets, amortization expense will be presented in the same line on the income statement as the fees for the associated hosted service on the Company’s Consolidated Statements of Operations, and the cash flows will be presented consistent with the presentation of cash flows for the fees related to the hosted service, generally as cash flows from operations, on the Company’s Consolidated Statements of Cash Flows. The Company does not expect such adoption will have a material impact on its financial position, results of operations or cash flows.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is part of the FASB’s initiative to reduce complexity in accounting standards. The proposed ASU eliminates certain exceptions to the general principles of ASC 740, Income Taxes, and simplifies income tax accounting in several areas. The standard is effective on January 1, 2021 with early adoption permitted. The Company plans to adopt early for the interim period ending March 31, 2020. The Company is evaluating the impact this ASU will have on its financial position, results of operations, cash flows, and disclosures, but does not expect such adoption to have a material impact.
3. Revenue from Contracts with Customers
The Company’s revenue from contracts with customers includes transaction fees and referral fees. Referral fees are presented as a component of “Other revenue” in the Consolidated Statements of Operations.
The following table presents the Company’s revenue from contracts with customers, disaggregated by revenue source for services transferred over time, for the years ended December 31, 2019 and 2018:
The Company recognizes transaction and referral fees at each distinct instance after the Company satisfies its performance obligations. The Company had no bad debt expense for the years ended December 31, 2019 and 2018. Because revenue is recognized at the same time that payments are received, the Company had no contract assets, contract liabilities, or deferred contract costs recorded as of December 31, 2019 and 2018. Additionally, the Company did not recognize any revenue from performance obligations related to prior periods (for example, due to changes in transaction price) for the years ended December 31, 2019 and 2018. For additional detail on the Company’s accounting policy regarding revenue recognition, see “Note 2. Summary of Significant Accounting Policies” above.
4. Net Loss Per Share
The following table details the computation of the Company’s basic and diluted net loss per share:
(1)
All share and per share information has been retroactively adjusted to reflect the reverse stock split discussed below.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The following table summarizes the weighted-average common shares that were excluded from the Company’s diluted net loss per share computation because their effect would have been anti-dilutive for the periods presented:
(1)
All share information has been retroactively adjusted to reflect the reverse stock split discussed below.
A 1-for-5 reverse stock split of the Company’s common stock became effective on July 5, 2019 (the Reverse Stock Split). All share and per share information contained in these consolidated financial statements has been retroactively adjusted to reflect the Reverse Stock Split. The par value per share of the Company’s common stock was not adjusted as a result of the Reverse Stock Split. Accordingly, the change in total par value was recorded in additional paid-in capital and has been retroactively adjusted for all periods in these consolidated financial statements.
5. Securities Available for Sale
The Company’s Structured Program transactions include i) asset-backed securitization transactions and ii) Certificate Program transactions. Certificate Program transactions include CLUB Certificate and Levered Certificate transactions.
In connection with asset-backed securitizations, the Company is the sponsor and establishes trusts to ultimately purchase the unsecured personal loans from the Company and/or third-party whole loan investors. Securities issued from our asset-backed securitizations are senior or subordinated based on the waterfall criteria of loan payments to each security class. The subordinated residual interests issued from these transactions are first to absorb credit losses in accordance with the waterfall criteria. The assets are transferred into a trust such that the assets are legally isolated from the creditors of the Company and are not available to satisfy obligations of the Company. These assets can only be used to settle obligations of the underlying trusts. The asset-backed securitization senior securities and subordinated residual interests retained by the Company are presented as “Asset-backed senior securities” and “Asset-backed subordinated securities,” respectively, in the securities available for sale tables below.
In addition, the Company sponsors the sale of unsecured personal loans through the issuance of certificate securities under our Certificate Program. The certificate securities are collateralized by loans transferred to a series of a master trust and trade in the over-the-counter market with a CUSIP. The assets are transferred into a trust such that the assets are legally isolated from the creditors of the Company and are not available to satisfy obligations of the Company. These assets can only be used to settle obligations of the underlying Certificate Program trusts. The CLUB Certificate issued securities are pass-through securities of which each owner has an undivided and equal interest in the underlying loans of each transaction. The Levered Certificate issued securities include senior and subordinated securities based on the waterfall criteria of loan payments to each security class. The subordinated securities issued from these transactions are first to absorb credit losses in accordance with the waterfall criteria. The CLUB Certificate issued securities retained by the Company are presented as “CLUB Certificate asset-backed securities” in the securities available for sale tables below.
The Levered Certificate issued senior and subordinated securities retained by the Company are presented in aggregate with securities from asset-backed securitizations as “Asset-backed senior securities” and “Asset-backed subordinated securities,” respectively, in the tables below. The “Other asset-backed securities” caption in the tables below primarily includes investment-grade rated bonds that are collateralized by automobile loan receivables.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The amortized cost, gross unrealized gains and losses, and fair value of securities available for sale as of December 31, 2019 and 2018, were as follows:
(1)
As of December 31, 2019 and 2018, $219.0 million and $115.1 million, respectively, of the asset-backed securities related to Structured Program transactions at fair value are subject to restrictions on transfer pursuant to the Company’s obligations as a “sponsor” under the U.S. Risk Retention Rules (as more fully described in “Part I - Item 1A. Risk Factors - Risk retention rules may increase our compliance costs, impair our liquidity and otherwise adversely affect our operating results.”)
(2)
As of December 31, 2019 and 2018, includes $174.8 million and $53.6 million, respectively, of securities pledged as collateral at fair value.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
A summary of securities available for sale with unrealized losses as of December 31, 2019 and 2018, aggregated by period of continuous unrealized loss, is as follows:
(1)
The number of investment positions with unrealized losses at December 31, 2019 and 2018 totaled 70 and 56, respectively.
During the years ended December 31, 2019, 2018 and 2017, the Company recognized $3.6 million, $3.0 million and $1.5 million, respectively, in other-than-temporary impairment charges on its asset-backed securities related to Structured Program transactions. There were no credit losses recognized into earnings for other-than-temporarily impaired securities held by the Company during the years ended December 31, 2019, 2018 and 2017 for which a portion of the impairment was previously recognized in other comprehensive income.
The contractual maturities of securities available for sale at December 31, 2019, were as follows:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
During the years ended December 31, 2019, 2018 and 2017, the Company, Consumer Loan Underlying Bond Depositor LLC (Depositor), a subsidiary of the Company, and a majority-owned affiliate (MOA) of the Company sold a combined $4.5 billion, $2.0 billion and $831.1 million, respectively, in asset-backed securities related to Structured Program transactions. There were no realized gains or losses related to such sales. For further information see “Note 7. Securitizations and Variable Interest Entities.” Proceeds and gross realized gains and losses from other sales of securities available for sale were as follows:
6. Loans Held for Investment, Loans Held for Sale, Notes, Certificates and Secured Borrowings
Loans Held for Investment, Notes, Certificates and Secured Borrowings
The Company issues member payment dependent notes and the LC Trust issues certificates as a means to allow investors to invest in the corresponding loans. At December 31, 2019 and 2018, loans held for investment, notes, certificates and secured borrowings measured at fair value on a recurring basis were as follows:
At December 31, 2019 and 2018, a fair value of $18.0 million and $76.5 million included in “Loans held for investment at fair value” was pledged as collateral for secured borrowings, respectively. See “Note 15. Secured Borrowings” for additional information.
The following table provides the balances of notes, certificates and secured borrowings at fair value at the end of the periods indicated:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Loans Invested in by the Company
At December 31, 2019 and 2018, loans invested in by the Company for which there were no associated notes, certificates or secured borrowings (with the exception of $40.3 million and $286.3 million in loans in consolidated trusts as of December 31, 2019 and 2018, respectively) were as follows:
The net fair value adjustments of $(28.4) million, $(30.6) million and $(16.6) million represent net unrealized losses recorded in earnings on loans invested in by the Company at December 31, 2019, 2018 and 2017, respectively. Total fair value adjustments recorded in earnings on loans invested in by the Company of $(141.0) million, $(102.0) million and $(25.8) million during the years ended December 31, 2019, 2018 and 2017, respectively, include net realized losses and changes in net unrealized losses. Net interest income earned on loans invested in by the Company during the years ended December 31, 2019, 2018 and 2017 was $80.9 million, $90.9 million and $39.8 million, respectively.
The Company used its own capital to purchase $5.3 billion in loans during the year ended December 31, 2019 and sold $5.1 billion in loans during the year ended December 31, 2019, of which $4.0 billion was securitized or sold to series trusts in connection with the Company’s Certificate Program and $1.1 billion was sold to whole loan investors. The fair value of loans invested in by the Company was $766.0 million at December 31, 2019, which was held for sale primarily for future anticipated Structured Program transactions and sales to loan investors. In the fourth quarter of 2019, the Company sponsored a new Structured Program transaction that was consolidated, resulting in the recognition of $40.3 million in loans held for investment by the Company at fair value and a related payable to securitization note and certificate holders of $40.6 million as of December 31, 2019. In May 2019, the Company deconsolidated a securitization trust, which resulted in the derecognition of $236.3 million in loans held for sale by the Company at fair value. See “Note 7. Securitizations and Variable Interest Entities” and “Note 14. Debt” for further discussion on the Company’s consolidated trusts and “Note 8. Fair Value of Assets and Liabilities” for a fair value rollforward of loans invested in by the Company for the years ended December 31, 2019 and 2018.
At December 31, 2019 and 2018, loans with a fair value of $551.5 million and $453.0 million included in “Loans held for sale by the Company at fair value” was pledged as collateral for the Company’s warehouse credit facilities, respectively. See “Note 14. Debt” for additional information related to these debt obligations.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Loans that were 90 days or more past due (including non-accrual loans) were as follows:
7. Securitizations and Variable Interest Entities
VIE Assets and Liabilities
The following tables provide the classifications of assets and liabilities on the Company’s Consolidated Balance Sheets for its transactions with consolidated and unconsolidated VIEs at December 31, 2019 and 2018. Additionally, the assets and liabilities in the tables below exclude intercompany balances that eliminate in consolidation:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Consolidated VIEs
The Company consolidates VIEs when it is deemed to be the primary beneficiary. See “Note 2. Summary of Significant Accounting Policies” for additional information.
LC Trust
The Company established the LC Trust for the purpose of acquiring and holding loans for the sole benefit of certain investors that have purchased trust certificates issued by the LC Trust. The Company is obligated to ensure that the LC Trust meets minimum capital requirements with respect to funding the administrative activities and maintaining the operations of the LC Trust.
Consolidated Trusts
The Company establishes trusts to facilitate the sale of loans and issuance of senior and subordinated securities. If the Company is the primary beneficiary of the trust, it is a consolidated VIE and will reflect senior and subordinated securities held by third parties as a “Payable to securitization note and certificate holders” in the Company’s Consolidated Balance Sheets. If subsequently the Company is not the primary beneficiary of the trust, the Company will deconsolidate the VIE. See “Note 2. Summary of Significant Accounting Policies” and “Note 14. Debt” for additional information.
Warehouse Credit Facilities
The Company established certain entities (deemed to be VIEs) to enter into warehouse credit facilities for the purpose of purchasing loans from LendingClub. See “Note 14. Debt” for additional information.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The following table presents a summary of financial assets and liabilities from the Company’s involvement with consolidated VIEs at December 31, 2019 and 2018:
The creditors of the VIEs above have no recourse to the general credit of the Company as the primary beneficiary of the VIEs and the liabilities of the VIEs can only be settled by the respective VIE’s assets.
Unconsolidated VIEs
The Company’s transactions with unconsolidated VIEs include asset-backed securitizations, Certificate Program transactions and loan sale transactions of unsecured personal loans. The Company has various forms of involvement with VIEs, including servicing of loans and holding senior or subordinated residual interests in the VIEs. The accounting for these transactions is based on a primary beneficiary analysis to determine whether the underlying VIEs should be consolidated. If the VIEs are not consolidated and the transfer of the loans from the Company to the VIE meets sale accounting criteria, then the Company will recognize a gain or loss on sales of loans. The Company considers continued involvement in an unconsolidated VIE insignificant if it is the sponsor and servicer and does not hold other significant variable interests. In these instances, the Company’s involvement with the VIE is in the role as an agent and without significant participation in the economics of the VIE. The Company enters into separate servicing agreements with the VIEs and holds at least 5% of the beneficial interests issued by the VIEs to comply with regulatory risk retention rules. The beneficial interests retained by the Company consist of senior securities and subordinated securities and are accounted for as securities available for sale. In connection with these transactions, we make certain customary representations, warranties and covenants. See “Note 2. Summary of Significant Accounting Policies” for additional information.
Investment Fund
The Company has an equity investment in a private fund (Investment Fund) that participates in a family of funds with other unrelated third parties. This family of funds purchases whole loans and interests in loans from the Company, as well as other assets from third parties unrelated to the Company. As of December 31, 2019, the Company had an ownership interest of approximately 23% in the Investment Fund. The Company’s investment is deemed to be a variable interest in the Investment Fund because the Company shares in the expected returns and losses of the Investment Fund. At December 31, 2019, the Company’s investment was $7.7 million, which is recognized in “Other assets” on the Company’s Consolidated Balance Sheets.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The following tables summarize unconsolidated VIEs with which the Company has significant continuing involvement, but is not the primary beneficiary at December 31, 2019 and 2018:
“Total VIE Assets” represents the remaining principal balance of loans held by unconsolidated VIEs with respect to Unconsolidated Trusts, Certificate Program transactions, and the net assets held by the Investment Fund using the most current information available. “Securities Available for Sale,” “Accrued Interest Receivable,” “Other Assets” and “Accrued Expenses and Other Liabilities” are the balances in the Company’s Consolidated Balance Sheets
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
related to its involvement with the unconsolidated VIEs. “Other Assets” includes the Company’s servicing assets and servicing receivables and the Company’s equity investment with respect to the Investment Fund. “Total Exposure” refers to the Company’s maximum exposure to loss from its involvement with unconsolidated VIEs. It represents estimated loss that would be incurred under severe, hypothetical circumstances, for which the Company believes the possibility is extremely remote, such as where the value of interests and any associated collateral declines to zero. Accordingly, this required disclosure is not an indication of expected losses.
The following table summarizes activity related to the unconsolidated trusts and Certificate Program trusts, with the transfers accounted for as a sale on the Company’s consolidated financial statements for the years ended December 31, 2019 and 2018:
(1)
For Structured Program transactions, the Company retained asset-backed senior securities of $98.7 million and $57.3 million, CLUB Certificate asset-backed securities of $101.3 million and $56.8 million, and asset-backed subordinated securities of $16.8 million and $8.3 million for the years ended December 31, 2019 and 2018, respectively.
Off-Balance Sheet Loans
Off-balance sheet loans primarily relate to Structured Program transactions for which the Company has some form of continuing involvement, including as servicer. Delinquent loans are comprised of loans 31 days or more past due, including non-accrual loans. For loans related to Structured Program transactions where servicing is the only form of continuing involvement, the Company would only experience a loss if it was required to repurchase a loan due to a breach in representations and warranties associated with its loan sale or servicing contracts.
As of December 31, 2019, the aggregate unpaid principal balance of the off-balance sheet loans pursuant to Structured Program transactions was $4.4 billion, of which $145.6 million was attributable to off-balance sheet loans that were 31 days or more past due. As of December 31, 2018, the aggregate unpaid principal balance of the off-balance sheet loans pursuant to Structured Program transactions was $2.3 billion, of which $87.1 million was attributable to off-balance sheet loans that were 31 days or more past due.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Retained Interests from Unconsolidated VIEs
The Company and other investors in the subordinated interests issued by trusts and Certificate Program trusts have rights to cash flows only after the investors holding the senior securities issued by the trusts have first received their contractual cash flows. The investors and the trusts have no direct recourse to the Company’s assets, and holders of the securities issued by the trusts can look only to the assets of the trusts that issued their securities for payment. The beneficial interests held by the Company and the Company’s MOA are subject principally to the credit and prepayment risk stemming from the underlying unsecured personal whole loans.
See “Note 8. Fair Value of Assets and Liabilities” for additional information on the fair value sensitivity of asset-backed securities related to Structured Program transactions.
8. Fair Value of Assets and Liabilities
For a description of the fair value hierarchy and the Company’s fair value methodologies, see “Note 2. Summary of Significant Accounting Policies.” The Company records certain assets and liabilities at fair value as listed in the following tables.
Financial Instruments, Assets and Liabilities Recorded at Fair Value
The following tables present the fair value hierarchy for assets and liabilities measured at fair value at December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
As presented in the tables above, the Company has elected the fair value option for certain liabilities. Changes in the fair value of these financial liabilities caused by a change in the Company’s risk are reported in other comprehensive income (OCI). For the year ended December 31, 2019, the amount reported in OCI is zero because these financial liabilities are either payable only upon receipt of cash flows from underlying loans or secured by cash collateral.
Financial instruments are categorized in the valuation hierarchy based on the significance of unobservable factors in the overall fair value measurement. Since the Company’s loans held for investment and related notes, certificates and secured borrowings, loans held for sale, loan servicing rights, asset-backed securities related to Structured Program transactions, and loan trailing fee liability do not trade in an active market with readily observable prices, the Company uses significant unobservable inputs to measure the fair value of these assets and liabilities. These fair value estimates may also include observable, actively quoted components derived from external sources. As a result, changes in fair value for assets and liabilities within the Level 2 or Level 3 categories may include changes in fair value that were attributable to observable and unobservable inputs, respectively. The Company primarily uses a discounted cash flow model to estimate the fair value of Level 3 instruments based on the present value of estimated future cash flows. This model uses inputs that are inherently judgmental and reflect our best estimates of the assumptions a market participant would use to calculate fair value. The Company did not transfer any assets or liabilities in or out of Level 3 during the years ended December 31, 2019 or 2018.
Fair valuation adjustments are recorded through earnings related to Level 3 instruments for the years ended December 31, 2019 and 2018. Certain unobservable inputs may (in isolation) have either a directionally consistent or opposite impact on the fair value of the financial instrument for a given change in that input. When multiple
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
inputs are used within the valuation techniques, a change in one input in a certain direction may be offset by an opposite change from another input.
Loans Held for Investment, Notes, Certificates and Secured Borrowings
Significant Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for loans held for investment, notes, certificates and secured borrowings at December 31, 2019 and 2018:
(1)
Expressed as a percentage of the original principal balance of the loan, note, certificate or secured borrowing.
Significant Recurring Level 3 Fair Value Input Sensitivity
At December 31, 2019 and 2018, the discounted cash flow methodology used to estimate the note, certificate and secured borrowings’ fair values used the same projected net cash flows as their related loans. As demonstrated by the following tables, the fair value adjustments for loans held for investment and loans held for sale were largely offset by the corresponding fair value adjustments due to the payment dependent design of the notes, certificates and secured borrowings.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Fair Value Reconciliation
The following table presents additional information about Level 3 loans held for investment, loans held for sale, and notes, certificates and secured borrowings measured at fair value on a recurring basis for the years ended December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Loans Invested in by the Company
Significant Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for loans invested in by the Company at December 31, 2019 and 2018:
(1)
Expressed as a percentage of the original principal balance of the loan.
Significant Recurring Level 3 Fair Value Input Sensitivity
The fair value sensitivity of loans invested in by the Company to adverse changes in key assumptions as of December 31, 2019 and 2018, are as follows:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Fair Value Reconciliation
The following table presents additional information about Level 3 loans invested in by the Company measured at fair value on a recurring basis for the years ended December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Asset-Backed Securities Related to Structured Program Transactions
Significant Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for asset-backed securities related to Structured Program transactions at December 31, 2019 and 2018:
(1)
Expressed as a percentage of the outstanding collateral balance.
Significant Recurring Fair Value Input Sensitivity
The following tables present adverse changes to the fair value sensitivity of Level 2 and Level 3 asset-backed securities related to Structured Program transactions to changes in key assumptions at December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Fair Value Reconciliation
The following table presents additional information about Level 3 asset-backed securities related to Structured Program transactions measured at fair value on a recurring basis for the years ended December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Servicing Assets
Significant Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for servicing assets at December 31, 2019 and 2018:
(1)
Expressed as a percentage of the original principal balance of the loan.
(2)
Includes collection fees estimated to be paid to a hypothetical third-party servicer.
Significant Recurring Level 3 Fair Value Input Sensitivity
The Company’s selection of the most representative market servicing rates for servicing assets is inherently judgmental. The Company reviews third-party servicing rates for its loans, loans in similar credit sectors, and market servicing benchmarking analyses provided by third-party valuation firms, when available. The table below shows the impact on the estimated fair value of servicing assets, calculated using different market servicing rate assumptions as of December 31, 2019 and 2018:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Fair Value Reconciliation
The following table presents additional information about Level 3 servicing assets measured at fair value on a recurring basis for the years ended December 31, 2019 and 2018:
(1)
Represents the gains or losses on sales of the related loans.
Loan Trailing Fee Liability
Significant Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for loan trailing fee liability at December 31, 2019 and 2018:
(1)
Expressed as a percentage of the original principal balance of the loan.
Significant Recurring Level 3 Fair Value Input Sensitivity
The fair value sensitivity of the loan trailing fee liability to adverse changes in key assumptions would not result in a material impact on the Company’s financial position.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Fair Value Reconciliation
The following table presents additional information about the Level 3 loan trailing fee liability measured at fair value on a recurring basis for the years ended December 31, 2019 and 2018:
Financial Instruments, Assets, and Liabilities Not Recorded at Fair Value
The following tables present the fair value hierarchy for financial instruments, assets, and liabilities not recorded at fair value:
(1)
Carrying amount approximates fair value due to the short maturity of these financial instruments.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
(1)
Carrying amount approximates fair value due to the short maturity of these financial instruments.
9. Property, Equipment and Software, Net
Property, equipment and software, net, consist of the following:
(1)
Includes $21.3 million and $10.3 million in development in progress as of December 31, 2019 and 2018, respectively.
Depreciation and amortization expense on property, equipment and software was $51.6 million, $47.0 million and $40.3 million for the years ended December 31, 2019, 2018 and 2017, respectively. The Company recorded impairment expense on its internally developed software of $3.9 million, $3.8 million and $2.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. The Company records impairment expense on its internally developed software in “Engineering and product development” expense in the Consolidated Statements of Operations.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
10. Other Assets
Other assets consist of the following:
(1)
Loans underlying loan servicing rights had a total outstanding principal balance of $14.1 billion and $10.9 billion as of December 31, 2019 and 2018, respectively.
11. Intangible Assets and Goodwill
Intangible Assets
Intangible assets consist of customer relationships. The gross and net carrying values and accumulated amortization as of December 31, 2019 and 2018, were as follows:
The customer relationship intangible assets are amortized on an accelerated basis over a 14 year period. Amortization expense associated with intangible assets for the years ended December 31, 2019, 2018 and 2017 was $3.5 million, $3.9 million and $4.3 million, respectively.
The expected future amortization expense for intangible assets as of December 31, 2019, is as follows:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Goodwill
Goodwill consists of the following:
During the annual testing for potential impairment of goodwill in 2018, management performed an assessment of the Company's patient and education finance reporting unit (PEF), which is the only reporting unit with goodwill. Upon completion of the annual impairment test, the Company recorded a goodwill impairment expense of $35.6 million during the second quarter of 2018, resulting in full impairment of the remaining goodwill of PEF.
12. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following:
(1)
See “Note 19. Commitments and Contingencies” for further information.
(2)
The Company adopted ASU 2016-02, Leases, as of January 1, 2019. As such, effective January 1, 2019, deferred rent is included within operating lease liabilities on the Company’s consolidated balance sheets. For additional information, see “Note 2. Summary of Significant Accounting Policies” and “Note 18. Leases.”
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
13. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) represents other cumulative gains and losses that are not reflected in earnings. The components of other comprehensive income (loss) were as follows:
Accumulated other comprehensive income (loss) balances were as follows:
14. Debt
Credit Facilities and Securities Sold Under Repurchase Agreements
The Company may enter into arrangements in the ordinary course of business pursuant to which the Company can incur indebtedness. Below is a description of certain of these arrangements:
Warehouse Credit Facilities
Through wholly-owned subsidiaries, the Company entered into secured warehouse credit facilities (Warehouse Facilities) with certain lenders from 2017 to 2019 to finance the Company’s personal loans and auto refinance loans and to pay fees and expenses related to the applicable facilities. Each subsidiary entered into a credit agreement and
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
security agreement with a commercial bank as administrative agent and a national banking association as collateral trustee and paying agent.
As of December 31, 2019, the warehouse facilities used to finance our personal loans (Personal Loan Warehouse Credit Facilities) have a combined borrowing capacity of $750.0 million (which will be reduced to $700.0 million on January 15, 2020) on a revolving basis and have “Commitment Termination Dates” ranging from March 2020 to October 2020, at which point the Company’s ability to borrow additional funds ends. Under the respective agreements, if not amended, extended, or replaced, any outstanding debt on the Commitment Termination Dates would be repaid as an amortizing term loan until the facility’s final maturity date. The Company is working to amend and extend the Commitment Termination Dates of these Personal Loan Warehouse Credit Facilities. The final maturity date occurs at the earlier of twelve months after the Commitment Termination Date and three years after these Personal Loan Warehouse Credit Facilities were executed, and any remaining debt is due in full at such time. Under the respective agreements, the Personal Loan Warehouse Credit Facilities mature between January 2021 and March 2022.
The warehouse facility to finance auto refinance loans (Auto Loan Warehouse Credit Facility) is a $34.2 million term loan that matures in June 2021, which has an outstanding balance of $14.3 million as of December 31, 2019. The amount borrowed under this Auto Loan Warehouse Credit Facility amortizes over time through regular principal and interest payments collected from the auto refinance loans that serve as collateral.
The creditors of the Personal Loan and Auto Loan Warehouse Credit Facilities have no recourse to the general credit of the Company. Borrowings under these facilities bear interest at an annual benchmark rate of LIBOR (London Inter-bank Offered Rate) or at an alternative commercial paper rate (which is either (i) the per annum rate equivalent to the weighted-average of the per annum rates at which all commercial paper notes were issued by certain lenders to fund advances or maintain loans, or (ii) the daily weighted-average of LIBOR, as set forth in the applicable credit agreement), plus a spread ranging from 1.85% to 2.50%. Interest is payable monthly. Borrowings may be prepaid without penalty. In addition, the Personal Loan Warehouse Credit Facilities require payment of a monthly unused commitment fee ranging from 0.375% to 1.25% per annum on the average undrawn portion available.
The Personal Loan and Auto Loan Warehouse Credit Facilities contain certain covenants. As of December 31, 2019, the Company was in material compliance with all applicable covenants under the respective credit agreements.
As of December 31, 2019 and 2018, the Company had $387.3 million and $306.8 million in aggregate debt outstanding under the Personal Loan and Auto Loan Warehouse Credit Facilities, respectively, with collateral consisting of loans at fair value of $551.5 million and $453.0 million included in “Loans held for sale by the Company at fair value,” respectively, and restricted cash of $25.1 million and $25.2 million included in the Consolidated Balance Sheets, respectively.
Revolving Credit Facility
In December 2015, the Company entered into a credit and guaranty agreement and a pledge and security agreement with several lenders and a financial services company, as collateral agent, for an aggregate $120.0 million secured revolving credit facility (Revolving Facility).
The Company may borrow under the Revolving Facility until December 17, 2020. Repayment of any outstanding proceeds are payable on December 17, 2020, but may be prepaid without penalty.
Borrowings under the Revolving Facility bear interest, at the Company’s option, at an annual rate of LIBOR plus a spread of 1.75% to 2.00%, which is fixed for a Company-selected interest period of one, two, three, six or twelve months, or at an alternative base rate (which is tied to either the prime rate, federal funds effective rate plus 0.50%, or the adjusted eurocurrency rate plus 1.00%, as defined in the credit agreement) plus a spread of 0.75% to 1.00%.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Base rate borrowings may be prepaid at any time without penalty, however pre-payment of LIBOR-based borrowings before the end of the selected interest period may result in the Company incurring expense to compensate the lenders for their funding costs through the end of the interest period. Interest is payable quarterly. Additionally, the Company is required to pay a quarterly commitment fee to the lenders of between 0.25% and 0.375% per annum, depending on the Company’s total net leverage ratio, on the average undrawn portion available under the Revolving Facility.
The Revolving Facility contains certain covenants. As of December 31, 2019, the Company was in material compliance with all applicable covenants in the credit and guaranty agreement.
The Company had $60.0 million and $95.0 million in debt outstanding under the Revolving Facility as of December 31, 2019 and 2018, respectively.
Repurchase Agreements
In 2018 and 2019, the Company entered into repurchase agreements pursuant to which the Company may sell securities (subject to an obligation to repurchase such securities at a specified future date and price) in exchange for cash, primarily to finance securities retained from the Company’s Structured Program transactions. The Company is subject to margin calls based on the fair value of the securities to be repurchased. As of December 31, 2019 and 2018, the Company had $140.2 million and $57.0 million in aggregate debt outstanding under its repurchase agreements, respectively, of which, at December 31, 2019, $64.5 million had contractual repurchase dates ranging from February 2020 to December 2026 and $75.7 million is subject to a repurchase date in March 2020 that requires counterparty approval to extend such repurchase date. The contractual repurchase dates correspond to either a set repurchase schedule or to the maturity dates of the underlying securities, which have a weighted-average estimated life from 1.1 to 1.4 years. The repurchase agreements bear interest at a rate that is based on a benchmark of the three-month LIBOR rate or the weighted-average interest rate of the securities sold plus a spread of 0.65% to 2.50%. Securities sold are included in “Credit facilities and securities sold under repurchase agreements” on the Consolidated Balance Sheets. As of December 31, 2019 and 2018, the Company had $174.8 million and $64.1 million, respectively, of underlying assets sold under repurchase agreements.
Payable to Securitization Note and Certificate Holders
In November 2019, the Company sponsored a securitization transaction through a master trust consisting of $44.7 million in unsecured personal whole loans. The trust sold certificate participations to third-party investors in an amount equal to 95% of the loans for $42.5 million in net proceeds. The remaining certificate participations and the residual interest were retained by the Company. The Company is the primary beneficiary of the trust, which is consolidated. As of December 31, 2019, the certificate participations held by third-party investors of $40.6 million are included in “Payable to securitization note and certificate holders” in the Consolidated Balance Sheets and were secured by loans held for investment by the Company at fair value of $40.3 million and restricted cash of $2.9 million included in the Consolidated Balance Sheets.
As of December 31, 2018, the Company was the primary beneficiary of a securitization trust that was consolidated. The notes held by third-party investors and the related unamortized debt issuance costs of $256.4 million are included in “Payable to securitization note and certificate holders” in the Consolidated Balance Sheets and were secured by loans held for sale by the Company at fair value of $286.3 million and restricted cash of $9.3 million included in the Consolidated Balance Sheets. In May 2019, the Company sold a portion of the residual certificates and no longer holds significant variable interest in the securitization trust. As a result, the Company deconsolidated the securitization trust, including the derecognition of the payable to securitization note holders.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
15. Secured Borrowings
In October 2017, LendingClub Asset Management, LLC (LCAM), a wholly-owned subsidiary of LendingClub that previously acted as the general partner for certain private funds, initiated the wind-down of six funds by redeeming the LC Trust certificates issued to the funds and transferring the loan participations underlying the redeemed certificates to third party investors. Certain of the loan participations for two of the funds transferred did not meet the definition of participating interests because the Company provided a credit support agreement under which the investor has a recourse to the Company for credit losses. The transfer of these loan participations from these two funds was accounted for as a secured borrowing and the underlying whole loans were not derecognized from the Company’s Consolidated Balance Sheets. The Company elected the fair value option for the secured borrowings.
As of December 31, 2019, the fair value of the secured borrowings was $20.1 million, secured by loans at fair value of $18.0 million included in “Loans held for investment at fair value” in the Consolidated Balance Sheets. As of December 31, 2018, the fair value of the secured borrowings was $80.6 million, secured by loans at fair value of $76.5 million included in “Loans held for investment at fair value” in the Consolidated Balance Sheets. Changes in the fair value of the secured borrowings are partially offset by the associated loan participations, and the net effect results in changes in fair value of the credit support agreement through earnings. As of December 31, 2019 and 2018, the fair value of this credit support agreement was $2.2 million and $2.8 million, respectively. The fair value of the credit support agreement is equal to the present value of the probability-weighted estimate of expected payments over a range of loss scenarios. See “Note 6. Loans Held for Investment, Loans Held for Sale, Notes, Certificates and Secured Borrowings” for additional information.
16. Employee Incentive and Retirement Plans
The Company’s 2014 Equity Incentive Plan (EIP) provides for granting awards, including RSUs, PBRSUs and stock options to employees, officers and directors. In addition, the Company offers a retirement plan to eligible employees.
Common Stock Reserved for Future Issuance
As of December 31, 2019 and 2018, the Company had shares of common stock reserved for future issuance as follows:
(1)
All share information has been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Stock-based Compensation
Stock-based compensation expense was as follows for the periods presented:
The following table presents the Company’s stock-based compensation expense recorded in the Consolidated Statements of Operations:
The Company capitalized $6.3 million, $9.1 million and $9.2 million of stock-based compensation expense associated with developing software for internal use during the years ended December 31, 2019, 2018 and 2017, respectively.
In 2016, the board of directors approved incentive retention awards to certain members of the executive management team and other key personnel. These incentive awards consisted of an aggregate of $16.3 million of RSUs and $18.6 million of cash. These incentive retention awards were recognized as compensation expense ratably through May 2017.
Restricted Stock Units
The following table summarizes the activities for the Company’s RSUs during the year ended December 31, 2019:
(1)
Amounts have been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
During the year ended December 31, 2019, the Company granted 7,531,283 RSUs with an aggregate fair value of $114.7 million.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
As of December 31, 2019, there was $151.0 million of unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over the next 2.8 years.
Performance-based Restricted Stock Units
PBRSUs are equity awards that are earned, and eligible for time-based vesting, based upon the achievement of certain pre-established performance metrics over a specific performance period. Depending on the level of achievement of the pre-established performance targets, the PBRSUs earned and eligible for time-based vesting can range from 0% to 200% of the target amount. PBRSUs granted under the Company’s EIP generally have a one-year performance period with the earned shares, if any, vesting over an additional approximately two-year period. Over the performance period, the number of PBRSUs that may be earned and the related stock-based compensation expense that is recognized is adjusted upward or downward based upon the probability of achieving the pre-established performance metrics.
During the first quarter of 2019, the Company expanded the use of its PBRSU program to nearly all of the executive team. The following table summarizes the activities for the Company’s PBRSUs during the year ended December 31, 2019:
(1)
Amounts have been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
(2)
Represents the portion of PBRSUs granted in 2018 that were unearned as a result of not achieving certain pre-established performance metrics during the performance period.
For the years ended December 31, 2019, 2018 and 2017, the Company recognized $3.9 million, $2.8 million and $1.0 million in stock-based compensation expense related to these PBRSUs, respectively.
As of December 31, 2019, there was $3.3 million of unrecognized compensation cost related to unvested PBRSUs, which is expected to be recognized over the next 1.7 years.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Stock Options
The following table summarizes the activities for the Company’s stock options during 2019:
(1)
Amounts have been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
(2)
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the Company’s closing stock price of $12.62 as reported on the New York Stock Exchange on December 31, 2019.
The aggregate intrinsic value of options exercised was $5.9 million, $1.9 million and $27.0 million for the years ended December 31, 2019, 2018 and 2017, respectively. The total fair value of stock options vested for the years ended December 31, 2019, 2018 and 2017 was $2.8 million, $9.8 million and $19.6 million, respectively.
As of December 31, 2019, the total unrecognized compensation cost related to outstanding stock options was $0.8 million, which is expected to be recognized over the next 0.5 years.
There were no stock options granted during the years ended December 31, 2019, 2018 and 2017.
Employee Stock Purchase Plan
The Company’s employee stock purchase plan (ESPP) became effective on December 11, 2014. The Company’s ESPP allowed eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions, subject to plan limitations. Payroll deductions were accumulated during six-month offering periods. The purchase price for each share of common stock was 85% of the lower of the fair market value of the common stock on the first business day of the offering period or on the last business day of the offering period. In connection with the Company’s cost structure simplification efforts, future purchases through the Company’s ESPP were suspended effective upon the completion of the most recent offering period on May 10, 2019.
The Company’s employees purchased 163,970, 361,840 and 261,907 shares of common stock under the ESPP during the years ended December 31, 2019, 2018 and 2017, respectively. As of December 31, 2019, 2018 and 2017, a total of 3,123,203, 2,307,400 and 1,739,199 shares remain reserved for future issuance, respectively.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The fair value of stock purchase rights granted to employees under the ESPP was measured on the grant date using the Black-Scholes option pricing model. The compensation expense related to ESPP purchase rights was recognized on a straight-line basis over the six-month requisite service period. We used the following assumptions in estimating the fair value of the grants under the ESPP, which were derived using the same methodology applied to stock option assumptions:
For the years ended December 31, 2018 and 2017, the dates of the assumptions were May 11, 2018 and November 11, 2018 and May 11, 2017 and November 11, 2017, respectively. There were no dates of assumption under the ESPP in 2019.
Retirement Plan
Upon completing 90 days of service, employees may participate in the Company’s qualified retirement plan that is governed by section 401(k) of the IRS Code. Participants may elect to contribute a portion of their annual compensation up to the maximum limit allowed by federal tax law. In the first quarter of 2016, the Company approved an employer match of up to 4% of an employee’s eligible compensation with a maximum annual match of $5,000 per employee. The total expense for the employer match for the years ended December 31, 2019, 2018 and 2017 was $4.5 million, $5.0 million and $4.4 million, respectively.
Stock Issued Related to Acquisition
As part of the Springstone acquisition in 2014, the sellers received shares of the Company’s Series F convertible preferred stock having an aggregate value of $25.0 million (Share Consideration). $22.1 million of the Share Consideration was subject to certain vesting and forfeiture conditions over a three-year period for key continuing employees. This was accounted for as a compensation agreement and expensed over the three-year vesting period. In conjunction with the conversion of preferred stock upon the IPO, these preferred shares were converted into common shares.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
17. Income Taxes
Loss before income tax expense (benefit) less income (loss) attributable to noncontrolling interests was $(30.9) million, $(128.3) million and $(153.2) million for the years ended December 31, 2019, 2018 and 2017, respectively. Income tax expense (benefit) consisted of the following for the periods shown below:
Income tax benefit and expense for the years ended December 31, 2019 and 2017, respectively, were primarily attributable to the tax effects of unrealized gains recorded to other comprehensive income associated with the Company’s available for sale portfolio. Income tax expense for the year ended December 31, 2018 was primarily attributable to current state income taxes, partially offset by the tax effects of unrealized gains recorded to other comprehensive income associated with the Company’s available for sale portfolio.
A reconciliation of the income taxes expected at the statutory federal income tax rate and income tax expense (benefit) for the years ended December 31, 2019, 2018 and 2017, is as follows:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
The significant components of the Company’s deferred tax assets and liabilities as of December 31, 2019 and 2018 were:
The Company continues to recognize a full valuation allowance against net deferred tax assets. This determination was based on the assessment of the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. As of December 31, 2019 and 2018, the valuation allowance was $169.5 million and $169.3 million, respectively.
As of December 31, 2019, the Company had federal and state net operating loss (NOL) carryforwards of approximately $397.3 million and $442.3 million, respectively, to offset future taxable income. The federal and majority of state NOL carryforwards start expiring in 2026 and 2028, respectively. Additionally, as of December 31, 2019, the Company had federal and state research and development credit carryforwards of $16.3 million and $16.4 million, respectively. The federal research credit carryforwards will expire beginning in 2026 and the state research credits may be carried forward indefinitely. As of December 31, 2019, the Company also had other state tax credit carryforwards of $2.2 million, which will expire beginning in 2020.
In general, a corporation’s ability to utilize its NOL and research and development credit carryforwards may be substantially limited due to the ownership change limitations as required by Section 382 and 383 of the Internal Revenue Code of 1986, as amended (Code), as well as similar state provisions. The federal and state Section 382 and 383 limitations may limit the use of a portion of the Company’s domestic NOL and tax credit carryforwards. Further, a portion of the carryforwards may expire before being applied to reduce future income tax liabilities.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
A reconciliation of the beginning and ending balance of total unrecognized tax benefits for the years ended December 31, 2019, 2018 and 2017, is as follows:
If the unrecognized tax benefit as of December 31, 2019 is recognized, there will be no effect on the Company’s effective tax rate as the tax benefit would increase a deferred tax asset, which is currently offset with a full valuation allowance. The Company recognizes interest and penalties related to unrecognized tax benefits within income tax expense. As of December 31, 2019, the Company had no accrued interest and penalties related to unrecognized tax benefits. The Company does not expect any significant increases or decreases to its unrecognized benefits within the next twelve months.
The Company files income tax returns in the United States and various state jurisdictions. As of December 31, 2019, the Company’s federal tax returns for 2015 and earlier, and the state tax returns for 2014 and earlier were no longer subject to examination by the taxing authorities. However, tax periods closed in a prior period may be subject to audit and re-examination by tax authorities for which tax carryforwards are utilized in subsequent years.
18. Leases
The Company has operating leases for its headquarters in San Francisco, California, as well as additional office space for its origination and servicing operations in the Salt Lake City area, Utah, and Westborough, Massachusetts. As of December 31, 2019, the lease agreements have remaining lease terms ranging from approximately two years to ten years. Some of the lease agreements include options to extend the lease term for up to an additional fifteen years and some of them include options to terminate the lease with six months’ prior notice. In addition, the Company is the sublessor of a portion of its office space in San Francisco, with lease terms ranging from two years to three years. As of December 31, 2019, the Company pledged $0.9 million of cash and $5.5 million in letters of credit as security deposits in connection with its lease agreements.
Balance sheet information as of December 31, 2019 related to leases was as follows:
(1)
The difference between operating lease assets and operating lease liabilities is the unamortized balance of deferred rent, which prior to January 1, 2019 was included as a separate liability within “Accrued expenses and other liabilities.”
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Components of net lease costs for the years ended December 31, 2019, 2018 and 2017, were as follows:
(1)
Includes variable lease costs of $1.6 million, $0.6 million and $0.4 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Supplemental cash flow information related to the Company’s operating leases for the year ended December 31, 2019 was as follows:
(1)
Represents non-cash activity and, accordingly, is not reflected in the Consolidated Statements of Cash Flows.
The Company’s future minimum undiscounted lease payments under operating leases and anticipated sublease revenue as of December 31, 2019 were as follows:
(1)
As of December 31, 2019, the Company entered into an additional operating lease which has not yet commenced and is therefore not part of the table above nor included in the lease right-of-use asset and liability. This lease will commence when the Company obtains possession of the underlying asset, which is expected to be on April 1, 2020. The lease term is nine years and has an undiscounted future rent payment of approximately $8.7 million.
The weighted-average remaining lease term and discount rate used in the calculation of the Company’s operating lease assets and liabilities were as follows:
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
19. Commitments and Contingencies
Operating Lease Commitments
For discussion regarding the Company’s operating lease commitments, see “Note 18. Leases.”
Loan Purchase Obligation
Under the Company’s loan account program with WebBank, which serves as the Company’s primary issuing bank for loans facilitated through the Company’s platform, WebBank retains ownership of the loans it originates for two business days after origination. As part of this arrangement, the Company is committed to purchase the loans at par plus accrued interest, at the conclusion of the two business days. As of December 31, 2019 and 2018, the Company was committed to purchase loans with an outstanding principal balance of $91.3 million and $55.9 million at par, respectively.
Loan Repurchase Obligations
The Company is generally required to repurchase loans or interests therein in the event of identity theft or certain other types of fraud on the part of the borrower or education and patient service providers. The Company may also repurchase loans or interests therein in connection with certain customer accommodations. In connection with certain whole loan and Certificate Program sales, as well as to facilitate access to securitization markets, the Company has agreed to repurchase loans if representations and warranties made with respect to such loans are breached under certain circumstances. In the case of certain securitization transactions, the Company has also agreed to repurchase or substitute loans for which a borrower fails to make the first payment due under a loan. The Company believes such provisions are customary and consistent with institutional loan and securitization market standards.
In addition to and distinct from the repurchase obligations described in the preceding paragraph, the Company performs certain administrative functions for a variety of retail and institutional investors, including executing, without discretion, loan investments as directed by the investor. To the extent loans do not meet the investor’s investment criteria at the time of issuance, or are transferred to the investor as a result of a system error by the Company, the Company repurchases such loans or interests therein at par.
As a result of the loan repurchase obligations described above, the Company repurchased $5.5 million, $4.0 million and $2.2 million in loans or interests therein during 2019, 2018 and 2017 respectively.
Purchase Commitments
As required by applicable regulations, the Company must make firm offers of credit with respect to prescreened direct mail it sends out to prospective applicants provided such applicants continue to meet the credit worthiness criteria which were used to screen them at the time of their application. If such loans are accepted by the applicants but not otherwise funded by investors on the platform, the Company is required to facilitate funding for the loans directly with its issuing bank partners. The Company was not required to purchase any such loans during 2019. Additionally, loans in the process of being facilitated through the Company’s platform and originated by the Company’s issuing bank partner at December 31, 2019, were substantially funded in January 2020. As of the date of this Report, no loans remained without investor commitments and the Company was not required to purchase any of these loans.
In addition, if neither the Company nor Springstone can arrange for other investors to invest in or purchase loans that Springstone facilitates and that are originated by an issuing bank partner but do not meet the credit criteria for purchase by the issuing bank partner, the Company and Springstone are contractually committed to purchase these
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
loans. As of December 31, 2019 and 2018, the Company had a $9.0 million deposit in a bank account to secure potential future purchases of these loans, if necessary. The funds are recorded as restricted cash on the Company’s Consolidated Balance Sheets. During the year ended December 31, 2019, the Company was required to purchase $45.3 million of loans facilitated by Springstone. These purchased loans are held on the Company’s Consolidated Balance Sheets and have a fair value of $45.7 million and $26.6 million as of December 31, 2019 and 2018, respectively. The Company believes it will be required to purchase additional loans facilitated by Springstone in 2020 as it seeks to arrange for other investors to invest in or purchase these loans.
Legal
The Company is subject to various claims brought in a litigation or regulatory context. These matters include lawsuits and federal regulatory actions, including but not limited to putative class action lawsuits, derivative lawsuits, and litigation with the FTC. In addition, the Company continues to cooperate in federal and state regulatory examinations, investigations, and actions relating to the Company’s business practices and licensing, and is a party to a number of routine litigation matters arising in the ordinary course of business. The majority of these claims and proceedings relate to or arise from alleged state or federal law and regulatory violations, or are alleged commercial disputes or consumer complaints. The Company accrues for costs related to contingencies when a loss from such claims is probable and the amount of loss can be reasonably estimated. In determining whether a loss from a claim is probable and the loss can be reasonably estimated, the Company reviews and evaluates its litigation and regulatory matters on at least a quarterly basis in light of potentially relevant factual and legal developments. If the Company determines an unfavorable outcome is not probable or the amount of loss cannot be reasonably estimated, the Company does not accrue for a potential litigation loss. In those situations, the Company discloses an estimate or range of the reasonably possible losses, if such estimates can be made. Except as otherwise specifically noted below, at this time, the Company does not believe that it is possible to estimate the reasonably possible losses or a range of reasonably possible losses related to the matters described below.
Derivative Lawsuits
In May 2016 and August 2016, respectively, two putative shareholder derivative actions were filed (Avila v. Laplanche, et al., No. CIV538758 and Dua v. Laplanche, et al., CGC-16-553731) against certain of the Company’s current and former officers and directors and naming the Company as a nominal defendant. Both actions were voluntarily dismissed without prejudice. On December 14, 2016, another putative shareholder derivative action was filed in the Delaware Court of Chancery (Steinberg, et al. v. Morris, et al., C.A. No. 12984-CB), against certain of the Company’s current and former officers and directors and naming the Company as a nominal defendant. In addition, on August 18, 2017, another putative shareholder derivative action was filed in the Delaware Court of Chancery (Fink, et al. v. Laplanche, et al., C.A. No. 2017-0600). These matters arise from claims that the Board allegedly breached its fiduciary duty by failing to provide adequate oversight over the Company’s practices and procedures, and purport to plead derivative claims under Delaware law. The Court ultimately consolidated the cases, selecting the Steinberg plaintiffs as lead plaintiffs, and designating the Steinberg complaint as the operative complaint (consolidated Delaware matter). In June 2018, the Company and the individual defendants brought a motion to dismiss the consolidated Delaware matter on demand futility grounds or in the alternative to stay the matter. Defendants in the consolidated Delaware matter later consented to the filing of a supplemental consolidated complaint in the case, and the plaintiffs filed that supplemental complaint on January 11, 2019. The Company and individual defendants in the case filed motions to dismiss the supplemental complaint on February 22, 2019. A hearing on these motions was held on July 17, 2019. On October 31, 2019, the Court issued a ruling dismissing the supplemental complaint for failure to plead that a majority of the directors on the Company’s board would have been unable to impartially consider a pre-suit demand. Plaintiffs did not file an appeal of the Court’s ruling by the deadline to file an appeal. The consolidated Delaware matter is therefore concluded.
On November 6, 2017, another putative shareholder derivative action was filed in the U.S. District Court for the Northern District of California (Sawyer v. Sanborn, et al., No. 3:17-cv-06447) against certain of the Company’s
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
current and former officers and directors and naming the Company as a nominal defendant. This action was based on allegations similar to those in a consolidated putative securities class action litigation (In re LendingClub Securities Litigation, No. 16-cv-02627 (N.D. Cal.)) that was successfully settled in 2018. The plaintiffs in the consolidated Delaware matter were permitted to join with the plaintiffs in the Sawyer action for the purposes of settlement. The Court in the Sawyer action concurrently ordered all parties (including the intervening consolidated Delaware matter plaintiffs) to participate in a mediation in May 2018, but that mediation did not result in a settlement.
In July 2018, the Company and the individual defendants brought a motion to dismiss the Sawyer matter on the grounds that the action was not filed within the applicable statute of limitations. The Court granted that motion and judgment was entered in favor of the defendants. The Sawyer plaintiff also attempted to intervene in a previously filed derivative action in the U.S. District Court for the Northern District of California (Stadnicki v. LaPlanche, et al., No. 3:16-cv-03072). The Company and the individual defendants opposed the intervention, and the original Stadnicki plaintiff moved to voluntarily dismiss the case. The motion to intervene was denied and the motion to voluntarily dismiss the Stadnicki action was granted. Notices of appeal were filed in both the Sawyer and Stadnicki actions. The appeal in the Sawyer matter has been dismissed at the Sawyer plaintiff’s request. The appeal in the Stadnicki matter remains pending and oral argument in that appeal was heard on February 3, 2020. It is not possible for the Company to predict the outcome of the Stadnicki action at this time.
FTC Lawsuit
In 2016, the Company received a formal request for information from the Federal Trade Commission (FTC). The FTC commenced an investigation concerning certain of the Company’s policies and practices and related legal compliance.
On April 25, 2018, the FTC filed a complaint in the Northern District of California (FTC v. LendingClub Corporation, No. 3:18-cv-02454) alleging causes of action for violations of the FTC Act, including claims of deception in connection with disclosures related to the origination fee associated with loans available through the Company’s platform, and in connection with communications relating to the likelihood of loan approval during the application process, and a claim of unfairness relating to certain unauthorized charges to borrowers’ bank accounts. The FTC’s complaint also alleged a violation of the Gramm-Leach-Bliley Act regarding the Company’s practices in delivering its privacy notice. In June 2018, the Company brought a motion to dismiss the FTC’s complaint, which was heard on September 13, 2018. In an order dated October 3, 2018, the Court denied the motion in part and granted the motion in part, providing the FTC with leave to amend its pleadings. On October 22, 2018, the FTC filed an amended complaint which reasserted the same causes of action from the original complaint. On November 13, 2018, the Company filed an answer to the amended complaint. The FTC subsequently filed a motion seeking to strike certain affirmative defenses pled in the answer and the Company filed an opposition to the motion. On April 29, 2019, the Court issued a ruling denying the FTC’s motion in part and granting it in part and allowing the Company to replead certain of the affirmative defenses that were the subject of the FTC’s motion. The Company filed an amended answer in the case on May 29, 2019. The discovery period in the case is closed. The Court has issued scheduling orders that set various deadlines in the case, including a June 22, 2020 trial commencement date. The Company denies, and will continue to vigorously defend against, the claims asserted in this case. Notwithstanding the Company’s vigorous defense, the Company and the FTC have participated in voluntary settlement conferences and may engage in additional settlement discussions. No assurances can be given as to the timing, outcome or consequences of this matter.
Class Action Lawsuits Following Announcement of FTC Litigation
In May 2018, following the announcement of the FTC’s litigation against the Company, putative shareholder class action litigation was filed in the U.S. District Court of the Northern District of California (Veal v. LendingClub Corporation et.al., No. 5:18-cv-02599) against the Company and certain of its current and former officers and
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
directors alleging violations of federal securities laws in connection with the Company’s description of fees and compliance with federal privacy law in securities filings. The Court appointed lead plaintiffs and lead counsel for the litigation in November 2018. On January 7, 2019, the lead plaintiffs filed a consolidated amended class action complaint which asserts the same causes of action as the original complaint and adds additional allegations. On March 8, 2019, the Company and the individual defendants in the case filed motions to dismiss the consolidated amended class action complaint. A hearing on these motions was held on September 26, 2019. On November 4, 2019, the Court issued a written order granting defendants’ motions to dismiss with leave to amend. Plaintiff filed a Second Amended Complaint on December 19, 2019, which modifies and adds certain allegations and drops one of the former officer defendants as a defendant in the case, but otherwise advances the same causes of action. Defendants filed a motion to dismiss the Second Amended Complaint on January 28, 2020. This lawsuit is in the early stages. The Company denies and will vigorously defend against the allegations. No assurances can be given as to the timing, outcome or consequences of this matter.
In July 2019, a putative class action lawsuit was filed against the Company in federal court in the State of New York (Shron v. LendingClub Corp., 1:19-cv-06718) alleging various claims including fraud, unjust enrichment, breach of contract, and violations of the federal Truth-in-Lending Act and New York General Business Law sections 349 and 350, et seq., based on allegations, among others, that the Company made misleading or inadequate statements or omissions in relation to the total cost and origination fee associated with loans available through the Company’s platform. The plaintiff seeks to represent classes of similarly situated individuals in the lawsuit. The Company has filed a motion to compel arbitration of plaintiff’s claims on an individual basis. The timing of a ruling on that motion is unclear. This matter is in the early stages. The Company denies and will vigorously defend against the allegations. No assurances can be given as to the timing, outcome or consequences of this matter.
Derivative Lawsuits Following FTC Litigation
In July 2018, a putative shareholder derivative action was filed in the U.S. District Court for the Northern District of California (Baron v. Sanborn, et al. No. 3:18-cv-04391) against certain of the Company’s current and former officers and directors and naming the Company as a nominal defendant. This action is based on allegations that the individuals breached their fiduciary duties to the Company and violated federal securities laws by, among other things, permitting the actions alleged in the FTC litigation and the description of fees and other practices in the Company’s securities filings. In January 2019, a second putative shareholder derivative action was filed in the U.S. District Court for the Northern District of California (Cheekatamarla v. Sanborn, et al., No. 3:19-cv-00563) against certain of the Company’s current officers and directors and naming the Company as a nominal defendant. Like the Baron action, this action is based on allegations that the individuals breached their fiduciary duties to the Company and violated federal securities laws by, among other things, permitting the actions alleged in the FTC litigation and the description of fees and other practices in the Company’s securities filings. Pursuant to a stipulation by the parties in both of these derivative cases, the Court consolidated the two cases and stayed the consolidated action pending further developments in Veal. In September 2019, co-lead counsel for plaintiffs in the consolidated action filed a notice and proposed order to lift the temporary stay and the Court issued an order lifting the stay. Subsequent to this order, the case was reassigned and the new Court issued an order staying the consolidated action pending resolution of the Veal action. No assurances can be given as to the timing, outcome or consequences of this consolidated matter.
In August 2019, a putative shareholder derivative action was filed in the Court of Chancery for the State of Delaware (Fisher v. Sanborn, et al., Case No. 2019-0631) against certain of the Company’s current and former officers and directors and naming the Company as a nominal defendant. This lawsuit advances allegations similar to those in the consolidated Baron/Cheekatamarla actions and the Veal action discussed above and accuses the individual defendants of breaching their fiduciary duties by failing to adequately monitor the Company and prevent it from engaging in the purported regulatory violations alleged by the FTC and by causing the Company to make allegedly false and misleading public statements (as alleged in the Veal action). The lawsuit also alleges that certain of the individual defendants breached their fiduciary duties by selling Company shares while in possession of
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
material, non-public information. On October 11, 2019, the Company and the individual defendants filed a motion to dismiss the complaint. In November 2019, rather than opposing defendants motion to dismiss, the plaintiff filed an amended complaint. That same month, the Company and the individual defendants named in the amended complaint filed a motion to dismiss that amended complaint. On January 17, 2020, rather than opposing defendants motion to dismiss, the plaintiff filed a second amended complaint. On January 24, 2020, defendants filed a motion to strike the second amended complaint as improper. No assurances can be given as to the timing, outcome or consequences of this matter.
Regulatory Investigation by the State of Massachusetts
In June 2018, the Company received a civil investigative demand from the office of the Attorney General of the State of Massachusetts. The investigation relates to the advertisement, provision and servicing of personal loans to Massachusetts’ consumers facilitated by the Company. The Company is cooperating with the investigation. The Company and the Attorney General’s Office have recently communicated regarding questions and concerns the Attorney General’s Office has regarding the Company’s compliance with the Massachusetts Small Loan Law and the Small Loan Rate Order promulgated under it. The Attorney General’s Office has also sent additional information requests to the Company. The Company has finalized an Assurance of Discontinuance with the Attorney General’s Office to resolve the investigation, the terms of which are not material to the Company’s financial position or results of operations.
In December 2019, the Massachusetts Division of Banks raised concerns pertaining to the Company’s compliance with the Massachusetts Small Loan Law similar to those the Massachusetts Attorney General’s Office raised during its investigation of the Company. No assurances can be given as to the timing, outcome or consequences of this matter; however, it could result in claims or actions against the Company, including litigation, regulatory enforcement actions, injunctions, monetary damages, fines or penalties, impact our licenses in Massachusetts, or require us to change our business practices or expend operational resources, all of which could result in a material loss or otherwise harm our business.
Regulatory Examinations and Actions Relating to the Company’s Business Practices and Licensing
The Company has been subject to periodic inquiries and enforcement actions brought by federal and state regulatory agencies relating to the Company’s business practices, the required licenses to operate its business, and its manner of operating in accordance with the requirements of its licenses. In the past, the Company has successfully resolved inquiries in a manner that was not material to its results of financial operations in any period and that did not materially limit the Company’s ability to conduct its business.
The Company has had discussions with the Colorado Department of Law (CDL) concerning the licenses required for the Company’s servicing operations and the structure of its offerings in the State of Colorado. The Company has also had discussions with the CDL about entering into a terminable agreement with the CDL to, among other things: (i) toll the statutes of limitations on any action the CDL might bring against the Company based on the rates and charges on loans the Company facilitates and (ii) refrain from facilitating certain loans to borrowers located in Colorado available for investment by certain investors. No assurances can be given as to the timing, outcome or consequences of this matter.
The Company is routinely subject to examination for compliance with applicable laws and regulations in the states in which it is licensed. As of the date of this Report, the Company is subject to examination by the New York Department of Financial Services (NYDFS). The Company periodically has discussions with various regulatory agencies regarding its business model and has recently engaged in similar discussions with the NYDFS. During the course of such discussions, which remain ongoing, the Company decided to voluntarily comply with certain rules and regulations of the NYDFS. No assurances can be given as to the timing, outcome or consequences of this matter.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Putative Class Actions
In September 2018, a lawsuit was filed against the Company in the State of New York (Accardo v. Lending Club, et al., 2:18-cv-05030-JS-AKT) asserting an individual claim under the federal Fair Credit Reporting Act against the Company. In early 2019, the plaintiff filed a motion for leave to amend his complaint in the case to assert a putative class claim under the Fair Credit Reporting Act. The plaintiff’s proposed amended complaint contends that LendingClub failed to conduct a reasonable investigation into plaintiff’s identity theft dispute and plaintiff seeks to represent a class of similarly situated individuals. The Company filed an opposition to plaintiff’s motion for leave to amend and also filed a motion to compel arbitration of plaintiff’s claim against the Company on an individual basis. The Court has denied the Company’s motion to compel arbitration and has ordered a trial on whether an arbitration agreement exists between the Company and Plaintiff. The Court also denied without prejudice Plaintiff’s motion for leave to amend. The Company has reached a tentative settlement with the plaintiff to resolve this matter, the terms of which are not material to the Company’s financial position or results of operations, and the parties are working to finalize a written settlement agreement. The Company denies and will vigorously defend against the allegations in the event the litigation continues. No assurances can be given as to the timing, outcome or consequences of this matter.
In February 2020, a putative class action lawsuit was filed against the Company in the U.S District Court for the Northern District of California (Erceg v. LendingClub Corporation, No. 3:20-cv-01153). The lawsuit alleges violations of California and Massachusetts law based on allegations that LendingClub recorded a call with plaintiff without notifying him that it would be recorded. Plaintiff seeks to represent a purported class of similarly situated individuals who had phone calls recorded by LendingClub without their knowledge and consent. LendingClub has not yet filed a formal response to plaintiff's complaint. No assurances can be given as to the timing, outcome or consequences of this matter.
California Private Attorneys General Lawsuit
In September 2018, a putative action under the California Private Attorney General Act was brought against the Company in the California Superior Court (Brott v. LendingClub Corporation, et al., CGC-18-570047) alleging violations of the California Labor Code. The complaint by a former employee alleges that the Company improperly failed to pay certain hourly employees for all wages owed, pay the correct rate of pay including overtime, and provide accurate wage statements. The lawsuit alleges that the plaintiff and aggrieved employees are entitled to recover civil penalties under the California Labor Code. On January 11, 2019, the Company filed a petition to compel arbitration of the plaintiff’s claims and stay the litigation pending a ruling on the motion and arbitration of the matter. Pursuant to the parties’ stipulation, in March 2019, the Court issued an order staying the lawsuit pending the parties’ participation in a mediation in September 2019. The parties have reached a resolution of this matter, the terms of which are not material to the Company’s financial position or results of operations. The resolution will require court approval. The parties have finalized a written settlement agreement and will seek the Court’s approval of the negotiated resolution.
Certain Financial Considerations Relating to Litigation and Investigations
With respect to the matters discussed above, the Company had $16.0 million and $12.8 million in accrued contingent liabilities as of December 31, 2019 and 2018, respectively. The increase in accrued contingent liabilities as of December 31, 2019 compared to December 31, 2018 was primarily related to litigation and regulatory matters of $3.3 million during 2019, which is included in “Other general and administrative” expense on the Company’s Consolidated Statements of Operations.
Class action and regulatory litigation expense related to significant governmental and regulatory investigations following the internal board review described more fully in “Management’s Discussion and Analysis of Financial
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
Condition and Results of Operations - Board Review” contained in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, was $35.5 million and $77.3 million for the years ended December 31, 2018 and 2017, respectively. This expense is included in “Class action and regulatory litigation expense” on the Company’s Consolidated Statements of Operations. The Company had no class action and regulatory litigation expense for the year ended December 31, 2019.
In addition to the foregoing, the Company is subject to, and may continue to be subject to, legal proceedings and regulatory actions in the ordinary course of business. No assurance can be given as to the timing, outcome or consequences of any of these matters.
20. Segment Reporting
The Company defines operating segments to be components of the Company for which discrete financial information is evaluated regularly by the Company’s executive management committee as chief operating decision maker (CODM). For purposes of allocating resources and evaluating financial performance, the Company’s CODM reviews financial information by loan product types of personal, education and patient finance, and auto. These product types are individually reviewed as operating segments but are aggregated to represent one reportable segment because the education and patient finance and auto loan product types are immaterial both individually and in the aggregate. In the second quarter of 2019, the Company sold certain assets relating to its small business operating segment and announced that it will connect applicants looking for a small business loan with strategic partners and earn referral fees, instead of facilitating these loans on its platform.
All of the Company’s revenue is generated in the United States. No individual borrower or investor accounted for 10% or more of consolidated net revenue for any of the periods presented.
21. Related Party Transactions
Related party transactions must be reviewed and approved by the Audit Committee of the Company’s board of directors when not conducted in the ordinary course of business subject to the standard terms of the Company’s lending marketplace or certificate investment program. Any material amendment or modification to an existing related party transaction is also subject to the review and approval of the Audit Committee. Related party transactions may include any transaction between entities under common control or with a related person that has occurred since the beginning of the Company’s latest fiscal year or is currently proposed. The Company has defined related persons as members of the board of directors, executive officers, principal owners of the Company’s outstanding stock and any immediate family members of each such related person, as well as any other person or entity with significant influence over the Company’s management or operations.
Several of the Company’s executive officers and directors (including immediate family members) have made deposits and withdrawals to their investor accounts and purchased loans or interests therein. The Company believes all such transactions by related persons were made in the ordinary course of business and were transacted on terms and conditions that were not more favorable than those obtained by similarly situated third-party investors.
As of December 31, 2019, the Company had a $7.7 million investment and an approximate 23% ownership interest in an Investment Fund, a private fund that participates in a family of funds with other unrelated third parties. This family of funds purchases whole loans and interests in loans from the Company, as well as other assets from third parties unrelated to the Company. The Company’s investment in the Investment Fund is recorded in “Other assets” on the Company’s Consolidated Balance Sheets.
During 2019, 2018 and 2017, the family of funds purchased $77 thousand, $6.6 million and $53.3 million, respectively, of whole loans. During 2019, 2018 and 2017, the Company earned $93 thousand, $262 thousand and $734 thousand in investor fees from this family of funds, and paid interest of $778 thousand, $2.9 million and
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
$7.4 million on the funds’ interests in whole loans, respectively. The Company believes that the investor fees charged were on terms and conditions that were not more favorable than those obtained by other third-party investors.
22. Subsequent Events
The Company has evaluated the impact of events that have occurred subsequent to December 31, 2019, through the date the consolidated financial statements were filed with the SEC. Based on this evaluation, other than as recorded or disclosed within these consolidated financial statements and related notes, including as disclosed below, the Company has determined no additional subsequent events were required to be recognized or disclosed.
On February 18, 2020, the Company and Radius Bancorp, Inc. (Radius) entered into an Agreement and Plan of Merger, by and among the Company, a wholly owned-subsidiary of the Company, and Radius, pursuant to which the Company will acquire Radius and thereby acquire its wholly-owned subsidiary, Radius Bank (the Merger), in a cash and stock transaction valued at $185 million (of which $138.75 million is in cash and $46.25 million is in stock), plus certain purchase price and expense adjustments of up to $22 million. The closing of the Merger is subject to regulatory approval and other customary closing conditions, which the Company anticipates can be completed within 15 months, as well as customary transaction costs. The Merger will be accounted for as a business combination. The purchase price will be allocated to the assets acquired and liabilities assumed based on their fair values at the acquisition date.
In order to facilitate compliance with federal banking regulations by the Company’s largest stockholder, Shanda Asset Management Holdings Limited and its affiliates (Shanda), on February 18, 2020, the Company entered into a Share Exchange Agreement pursuant to which Shanda will exchange all shares of the Company’s common stock held by Shanda for newly issued non-voting convertible preferred stock, series A (the Exchange). In connection with the Exchange, the Company will provide Shanda registration rights and a one-time cash payment of approximately $50 million. To deter future ownership positions in the Company’s securities in excess of thresholds set forth by the Federal Reserve under the Bank Holding Company Act, the Company adopted a Temporary Bank Charter Protection Agreement (the Charter Protection Agreement) which provides for the dilution of any person or group of persons that acquires: (i) 25% or more equity interest in the Company, or (ii) 7.5% or more of any class of the Company’s voting securities, which threshold shall automatically increase to 10% in connection with the closing of the Exchange. The Charter Protection Agreement is effective as of February 18, 2020, and will automatically expire on the earlier of the closing of the Merger or 18 months. The Company is evaluating the impact the Exchange will have on its consolidated financial statements.
23. Quarterly Results of Operations (Unaudited)
The following table sets forth our unaudited Consolidated Statements of Operations data for each of the eight quarters ended December 31, 2019. The unaudited quarterly statements of operations data set forth below have been prepared on the same basis as our audited consolidated financial statements and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for a fair statement of the unaudited quarterly statements of operations data. Our historical results are not necessarily indicative of our future operating results. The following quarterly consolidated financial data should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this Report.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
(1)
See “Note 1. Basis of Presentation” for additional information.
(2)
Loan originations include loans facilitated through the platform plus outstanding purchase commitments at period end. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Key Operating and Financial Metrics” for additional information.
(3)
All share and per share information has been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Amounts, Ratios, or as Noted)
(1)
See “Note 1. Basis of Presentation” for additional information.
(2)
Loan originations include loans facilitated through the platform plus outstanding purchase commitments at period end. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Key Operating and Financial Metrics” for additional information.
(3)
All share and per share information has been retroactively adjusted to reflect a reverse stock split. See “Note 4. Net Loss Per Share” for additional information.
LENDINGCLUB CORPORATION
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s management evaluated, with the participation of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2019. In designing and evaluating its disclosure controls and procedures, the Company’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance, not absolute assurance, of achieving the desired control objectives, and is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures as of December 31, 2019, were designed and functioned effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities and Exchange Act of 1934, as amended, is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for maintaining effective internal control over financial reporting and for assessing the effectiveness of internal control over financial reporting, as defined in Rule 13a-15(f) of the 1934 Act. Under the supervision and with the participation of the Company’s CEO and CFO, management conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2019, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As a result of this assessment, management concluded that, as of December 31, 2019, our internal control over financial reporting was effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Deloitte & Touche LLP, has independently audited the effectiveness of our internal control over financial reporting and its report is included below.
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention or overriding of controls. Further, because of changes in conditions, the effectiveness of internal controls may vary over time. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Changes in Internal Control Over Financial Reporting
No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter ended December 31, 2019, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of LendingClub Corporation
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of LendingClub Corporation and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 19, 2020, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
February 19, 2020
LENDINGCLUB CORPORATION
Item 9B.
Item 9B. Other Information
Not Applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 will be included in our definitive proxy statement with respect to our 2020 Annual Meeting of Stockholders (Proxy Statement) and is incorporated herein by reference. The Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days of the end of the 2019 fiscal year.
Item 11.
Item 11. Executive Compensation
The information required by Item 11 will be included in the Proxy Statement under the headings “Board of Directors and Corporate Governance - Director Compensation,” “Executive Compensation” and “Report of the Compensation Committee,” and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 will be included in the Proxy Statement under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance Under Equity Compensation Plans,” and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 will be included in the Proxy Statement under the headings “Related Party Transactions” and “Board of Directors and Corporate Governance - Director Independence,” and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 will be included in the Proxy Statement under the heading “Ratification of Appointment of Independent Registered Public Accounting Firm,” and is incorporated herein by reference.
LENDINGCLUB CORPORATION
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
(a) Documents filed as part of this Annual Report on Form 10-K:
1.
Financial Statements
The following consolidated financial statements are included in Part II, Item 8 of this Annual Report on Form 10-K:
2.
Financial Statement Schedule
Financial statement schedules have been omitted because they are not required, not applicable, not present in amounts sufficient to require submission of the schedule, or the required information is shown in the Consolidated Financial Statements or Notes thereto.
3.
Exhibits
The documents listed in the Exhibit index of this Annual Report on Form 10-K are incorporated by reference or are filed with this Annual Report on Form 10-K, in each case as indicated therein on the Exhibit Index immediately following the signature page of this Annual Report on Form 10-K.
Item 16. Form 10-K Summary
None.
LENDINGCLUB CORPORATION
EXHIBIT INDEX
LENDINGCLUB CORPORATION
LENDINGCLUB CORPORATION
*
Confidential treatment has been requested for certain portions of this Exhibit. The omitted material has been filed separately with the SEC.
**
Certain information in the exhibit was omitted pursuant to Item 601(b)(2) of Regulation S-K because it is both not material and would be competitively harmful if publicly disclosed. The Company undertakes to furnish, supplementally, a copy of the unredacted exhibit to the SEC upon request.
†
Schedules have been omitted as they are not material, not applicable or not required. They will be furnished supplementally to the SEC upon request.
LENDINGCLUB CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 19, 2020
LENDINGCLUB CORPORATION
By:
/s/ Scott Sanborn
Scott Sanborn
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Scott Sanborn and Thomas Casey, jointly and severally, his or her attorney-in-fact, with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
LENDINGCLUB CORPORATION
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.