Thoughts on Goldman vs Lending Club

The NY Times had a report last week that Goldman Sachs (GS) is exploring an entrance into the consumer lending market.  Comparisons have been made between what Goldman has in mind for consumer lending and the company Lending Club (LC) that went public last year.

To understand Lending Club and Goldman's vision of consumer lending we need to discussion traditional lending first.

Traditional Lending

In a traditional banking model, a bank funds a loan through customer deposits.  A bank's source of funding is their customer's deposits.  Traditionally banks pay a small amount on deposits to compensate depositors for access to their money.  Deposit funding costs are low.  In the first quarter of 2015 banks paid an average of .44% in funding costs.

A bank makes money on the spread between the interest received on the loan and the interest paid on their funding (deposits).  If a bank makes a mortgage loan to a borrower at 4% and pays .5% in funding costs they earn a 3.5% net interest margin.  Operating costs to service the loan as well as providing the infrastructure to take in deposits and make loans is subtracted from that 3.5% spread as well as taxes and the resulting value is a bank's net income.

Banks can make money by lending to consumers then keeping the loan on their books and earning the spread.  Banks engage in all types of lending, consumer, credit card, auto, residential, and commercial.  Of those types residential lending is viewed as the safest and rates are the lowest as a result.  Moving up the ladder commercial loans are viewed as risker followed by auto, consumer loans and finally credit cards.

The truth is it's really a toss-up in terms of risk, sometimes commercial loans are much safer than residential loans, and residential loans aren't always safe.  On average banks are usually good at assessing risk.  A loan to IBM might carry a 1% rate, whereas a loan for a sub-prime auto might carry a 15% or 20% rate.  IBM is a good credit and it's almost assured they will pay back their notes.  A troubled car borrower is dicier.  Compound that with little residual value for the auto itself and it's easy to see why rates are so high for poor credits.

Banks usually like to diversify their lending mix.  This is in an effort to both manage risk, exposure, and increase their net interest margin.

The New Model

Lending Club is not a traditional bank as most consumers think of banks.  They own a small bank, Webbank located in Utah, but they are not a traditional lender.  The company is not funded via customer deposits, and they aren't focused on earning a spread via the bank.  There bank holds certain types of loans on their books and for the most part are just an intermediary for the rest of the Lending Club system.

Lending Club makes money by originating loans and selling those loans to investors.  The company takes a 5% origination cut off the top of the loan and then receive 1% of interest for each loan.  As an example if a borrower were to take out a $10,000 loan at 9% Lending Club would receive 1% in interest and investors would receive 8% for backing this loan.  Loans are funded by selling notes to investors.

From a borrowers perspective Lending Club is no different than a traditional bank.  A consumer requests a loan, the company conducts a credit check and if they deem them worthy they'll extend credit.  The borrower then pays back their loan with monthly payments.  Lending Club takes a portion of the payments and passes the rest onto investors in their notes.

If any investor were to read the Lending Club website it would appear that investors fund specific loans and receive payments from said loans.  But that's only partially true.  The Lending Club notes are simply derivative securities, the note itself is to Lending Club corporate, and the company then promises to forward on payments from borrowers to the investor minus service fees.

Lending Club makes money on the initial origination as well as service fees and the 1% of the interest rate paid by borrowers.

The actual notes are fairly complex.  A prospectus is available on the SEC website and contains general details of how the mechanics of the investing and loan funding process work.  Investors are buying Lending Club notes, and then Lending Club pays investors based on what notes the investor has selected via the website.  If a borrower defaults the investor has zero recourse, they don't have an actual claim on the loan like a bank would.  If Lending Club were to declare bankruptcy the investors don't have a claim on Lending Club, the claim directs to the interest in the underlying note.

Lending Club's costs are much higher than a traditional bank's costs.  Any student of the capital markets knows that equity financing carries the highest cost of all types of financing.  But for Lending Club the equity financing isn't borne by them, it's someone else's money.

Can it work?

The Lending Club model is different from a traditional banking model.  Lending Club needs to keep their origination volume strong and growing if they want to increase their revenue stream.  They aren't making much money on each loan so they can't just originate loans then sit and collect interest for years like a bank can.

This creates a unique incentive, the incentive is for Lending Club to drive loan volume regardless of credit quality.  If borrowers default Lending Club itself doesn't recognize a loan loss, they simply lose their 1% ongoing interest stream.  The company makes the bulk of their money upfront.

The company claims on their website that they have a premier platform and can conduct this type of lending profitably because of a low cost IT platform.  Supposedly banks with their high cost personnel and traditional infrastructure are outdated compared to this new IT paradigm.

The problem is the company's financial statements don't match up with what they're saying publicly.  In the most recent quarter they generated $81m from originations and service fees and had $86m in expenses.  Expenses broke down as following, $35m in sales and marketing (to keep the origination machine running), $12m in origination costs, $12m in engineering and development and $27m in "other".  The company reported a GAAP loss, but if investors pretend that stock compensation isn't a true expense then the company was profitable on an adjusted-EBITDA basis.

Lending Club has originated over $9b in loans since they started.  For comparisons sake let's look at them compared to a bank with $9b in loans.  I ran a search on and came up with Apple Bank for Savings located in NY.  They had slightly over $9b worth of loans in the first quarter of 2015.  As a comparison it only took Apple Bank for Savings $29m ($16m in salaries, $13m in premise, data etc) to manage this amount of money.  Apple Bank for Savings earned $10.2m for the quarter, a far cry from Lending Club's loss of $6m.

Of course this isn't a perfect comparison.  Apple Bank for Savings specializes in mostly residential and commercial lending.  And they are funded by deposits.  But the comparison shows that there is a lot of value in being able to keep lower interest but profitable loans on the balance sheet and earning a spread.

Lending Club is a fundamentally different model compared to traditional banking.  Lending Club's model is driven by originations and fees on their loans, not the rates charged to consumers.

The attraction to this model for Goldman Sachs should be obvious.  Lending Club is raising funding capital from ordinary investors for their derivative notes whereas Goldman Sachs has a pipeline to institutional capital.  Goldman Sachs are experts at raising funds for special purpose entities that are eventually repackaged and then sold again to other (or the same) investors.

Lending Club is raising money at the retail level, $25 at a time.  Goldman Sachs can come into the market as a whale given their connections to capital and experience securitizing loans.

If I were to wager I'd say that Goldman Sachs will create a newly named consumer loan unit without the Goldman name on the letter head.  This newly created entity will begin to spam American mailboxes offering loans at 15-25% rates.  Goldman will then package these loans and sell them back into the market pushing the risk of a default onto investors, the same way Lending Club does.

The risk to this business model is it requires a steady stream of new originations.  If loan origination volume doesn't stay steady or grow the company could have issues coving their costs.  Lending Club hopes to eventually make money on their origination and service fees.  I'd imagine Goldman Sachs has the same idea, although I'm sure they'll make a little extra on the back end of the deal as well when they resell their packaged securities.  This is where Goldman has an edge.  They can make money up front and make money on the back trading these securities between clients.

Risk will appear when the "good" (good in a relative sense, not many truly good credits are borrowing at high rates) credit dries up and the company continues to make loans to poor quality borrowers in order to hit their origination metrics.

The real risk will be borne by the investors in these notes.  Whereas Lending Club investors can select the types of loans they'd like to be exposed to it's likely Goldman will do the selecting themselves and offer their clients pre-packaged securities.  We've seen what can happen to pre-packaged securitizations of low quality credits in the past, let's hope history doesn't repeat.

Comments (13)

Jun 24, 2015

You explicitly state that this is very similar to past "pre-packaged securitization of low quality credits", so I'm not 100% sure why people would be duped into the same thing again.

Could you explain how these are different from the business of CDSs in the past?

happy to give advice; no asking for referrals please

Jun 24, 2015

Also i think that Lending Club in it's financial statements will not differentiate between good or bad loans, that's th investor's problem
and also stock compensation has hidden cost, PV of net cash drain from future cash payments to the common stock

Jun 24, 2015

Soooo they're pretending to re-invent CLO's sans the tranches? Its the exact same thing.

Jun 24, 2015

LC doesn't have the same funding risk as a bank despite its transactional nature. One might argue that many loans are recurring over time (eg. I need to constantly refinance as my maturities come due) which limits the risk of obtaining originations, but I agree that competition is a major obstacle for growth. People won't generally care who their funding sources are but investors will given in a default, there needs to be protections that ensure that the middle man can recover some cash from the borrower. LC has a good platform for that and I'm sure a lot of their opex is spent on collection agencies and loan management. I'm not sure LC can hit its growth targets without another line of business so I'm curious what that will be

Jun 24, 2015

I have about $20k sitting in LendingClub, I'm now into I think my 7-8th month of using them (3 year minimum locking period). It's doing okay so far, about 8.3-9.3% annualized. They make it hard to keep track of loans that have late payments on them, so just keep track of them manually. Out of about 200 loans I have, in the 7-8 months I've had late payments so far on about maybe 5?... So not all that bad. Funny though most of the late ones end up being the A grade loans I invested in. I have a spread of approx 70-80% A/B grade and 20% of the higher risk ones.

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Jun 25, 2015

Is there an European/international equivalent of LC? Seems to be limited only to the US.

Jun 25, 2015

In the UK there is Zopa, RateSetter, and Funding Circle.

Jun 25, 2015

@evilmindbulgaria I'm sure there is a European equivalent to LC in Europe...I just don't know of any off the top of my head.

LC and Prosper have paved the way for crowd funding where investors get an actual return instead of a T-Shirt or mention on a startups website. Beyond LCs model you also have Bond Capital which provides loans to small businesses without taking investor money directly (I think they do it through private institutionalized investors and not just Joe Somebody)

You also have real estate crowd funding where you can invest in real estate developments and there is also small business lending similar to LC such as REAMERGE which takes investor funds and loans them out to vetted small businesses (primarily convenience stores). Difference with these guys is that they have a lien on the business so in case of default they can liquidate assets (e.g. Pumps, store front, inventory, etc) and return the investments back to you.

I'm closely watching the innovation in this space because it will definitely impact everyone from banks to investment banks. For example, I'm interested to see as @Oddball Stocks mentioned if Goldman creates a subsidiary that invests in consumer and small business loans how they plan on developing a securitization food chain whereby these loans can be pooled together and sold to investors.

Perhaps investors can buy CDS to protect themselves against these investments that they make similar to CDS on sub-prime loans?

Another BIG thing is to see who can create a secondary market for these types of loans that can be bought and sold like Bonds. Should be fun to see what happens next...

Jul 5, 2015

Not impressed by REAMERGE at all. Have you checked out their website? And management team? :-/ One of the guys is a part time medical doctor or something and the other is someone appearing to be in the family (same last name - spouse?). I believe the profit rates were around 4% there but I'm not investing there at all, I wasn't impressed by their site and you can't see their loan inventory without them personally calling you. Seemed shady.

Jul 7, 2015

@wallstreet246 I have checked their website and I have contacted their management team and spoken with them at length. As for the team I believe they are siblings which to me is irrelevant as I care about the content and overall level of service from the platform and not how they are affiliated with each other.

Curious to see how you came up with the 4% figure...mind explaining? As for not being able to see the loan inventory, the reason for this is that crowd funding portals are bound by specific rules with respect to the JOBS Act. In short the portal must determine that you are either A.) An accredited investor and or B.) A knowledgeable investor who understands the risk(s) involved (this depends on which rule the crowd funding portal operates on i.e. 506(c), Title III, Rule 504 to name a few).

The platform must follow the rules and determine the above prior to showing the loan inventory or offerings. Fundrise, for example only shows the deals which have been funded and requires you to sign up and prove that you are an accredited investor prior to showing you their open deals.

I don't consider REAMERGE shady as I have spoken with their team and have found them to be knowledgeable in the area that they are focused on (primarily convenience and gas stations). In addition they were recently invited to pitch at the LendIt Conference in New York held in April of this year. If they were shady I HIGHLY doubt a conference as big as LendIt which is attended by everyone from major Investment Banks to VC and PE firms would invite them to pitch their platform to investors.

List of REAMERGE and other PitchIt participants in case you're curious:

Jul 7, 2015

LOL, the site is down as of now (July 7th, 10:55-11:15pm NYC time) so yeah....... maybe they should move to AWS Cloud at $40 a month lol.

Also, looks like a week after signing up, my account doesn't exist on their site anymore. Anyway, I created another one to look into the 4% claim. The last time I logged in, there was some page that had some sample or featured investments where I noticed the 4% - it no longer exists. So don't quote me, this is not my turf I don't own the portal and don't really care if it's 4%, 8% or 40%.. I'll take that claim back since I never took a screen shot. Perhaps I miscalculated (or perhaps I didn't). It appeared to me like a 8% annual return but because the capital is returned month by month, the left over capital each month reduces so the net net annual return was not the whole number you'd see at first thoughts... some confusion on those lines.

Meanwhile, I have plenty of other places to invest my (tiny sum of) money.. over a 2-3 person team with little to none wall street "branding" relative to the high finance world of private equity, hedge funds and what not (just in my personal opinion) funding gas stations (does anyone see what I see here?), so thanks but no thanks. For starters, Lending Club has an investor/partner relationship with Google. And look at the founder/board profiles at LC, a bunch of Wall St / Ivy League names there. I mean come on, all over this portal, people are dick bashed for being from a technology background trying to even think of anything front office, and you think the same people here are going to put up capital with someone who is a medical doctor, software guy as well as a ReEmearge owner all in one (and NOT from Harvard / Wharton / Google / GS / blah blah) towards a gas station? :-/

Net net, I'm just saying.. a place like WSO comes with a lot of snobbery over branding. I don't think this portal is going to get much investment interest from WSO folk once they do their due diligence on the portal. Perhaps over time this may change as marketing and PR efforts get better. Just my personal opinion. I'm not asking for much here. The world of investing and entrepreneurship comes with a lot of smoke-and-mirrors-do-u-know-how-to-sell-horse-shit perception and with that I say reeamearge could have done much better. It doesn't cost much to put up a fancy website and a fancier advisory board (in my opinion).

Jul 8, 2015

@wallstreet246 I'm not sure why you weren't able to access the site...LendIt is working just fine for me this morning at 8:08 AM CST.

I'm not trying to pitch REAMERGE nor do I care if anyone takes interest in it. My point in bringing them up was that this is an area that is diversifying and may be a good avenue for retail investors not willing or wanting to take the plunge into the stock market, bonds, etc.

If you have the funds to invest with hedge funds or whatnot, great for you...more power to you. My aim was to answer OPs question and continue the discussion about private lending however, like other threads non-IBD, PE, or hedge fund related they quickly fizzle and are forgotten.

Been up for a while so apologizes if this post sounds incoherent.

Aug 30, 2017