LendingClub raised eyebrows early last year when it announced that it was buying a bank.
The company's $185 million acquisition of Radius Bank made LendingClub the first fintech to acquire a regulated bank.
But Wall Street wasn't impressed. The company's stock shed two-thirds of its value in the months that followed the February 2020 announcement.
There was a different reaction two weeks ago: LendingClub reported second-quarter earnings with a surprising profit, and its shares soared 50%, continuing a run that's seen the stock grow more than 500% from its mid-2020 nadir. One analyst on the company earnings call was so impressed, he opened the Q&A section with the remark: "Let me be a little exuberant here. This is amazing."
CEO Scott Sanborn highlighted a key reason for the results: Gobbling up Radius Bank clearly paid off. The acquisition, which closed in February, was key to LendingClub's transformation from a peer-to-peer lending marketplace — a business model it fully abandoned in December — into a full-fledged bank.
It was a dramatic turn for a fintech pioneer, which was once the world's biggest peer-to-peer lender but got mired in scandal a few years ago. An internal probe of improprieties around loans sold to an institutional client led to the exit of co-founder and former CEO Renaud Laplanche.
LendingClub's rebound puts the spotlight on changing views of the role of banking within fintech. Many fintechs launched by partnering with a bank, viewing obtaining a bank charter as an unnecessary or even risky step that could stifle innovation and slow them down.
In an interview with Protocol, Sanborn discussed why LendingClub saw things differently, and how becoming a bank led to the company's earnings "surprise" and transformed it into a stronger player in financial services.
It wasn't easy. Sanborn also recalled how COVID-19 essentially forced LendingClub to hit pause as it prepared in the middle of a global pandemic to pivot from peer-to-peer lender to a bank — what fintechs need to remember if they're considering going down the banking path.
This interview has been edited for clarity and brevity.
Your earnings report was called a surprise. Were you surprised?
It's fair to say that the results were better than we anticipated. We did expect that with the acquisition of the bank and our re-entry into the market, we'd be able to demonstrate what the combined entity could do. We were pleased at the pace at which we're able to get it done and demonstrate those results. In a way, we sort of pulled our plan in. And that was a combination of the new capabilities that we acquired together with some infrastructure builds we did during COVID. That enabled us to move much more quickly and execute more quickly to adapt to the changing market conditions.
How did buying Radius Bank help you achieve these results?
I'll talk about two that drove the results. One is financial. We knocked out very, very significant costs. For the marketplace portion of our business, where the loans are funded by investors, we used to warehouse loans for that and pre-COVID, we had $1 billion we paid for at a funding cost of 330 basis points.
So that cost goes away because we swap it for deposits, which right now are 30 basis points. That knocks out a big expense.
The other big expense that we've eliminated [involved] issuing banks. In our prior model, we worked with partner banks to issue loans, and they earned a fee in exchange for that loan issuance. They also earned about $30 million pre-COVID. Those are two expenses we recaptured.
We also added a whole new revenue stream, interest income. We used to sell all of the loans that we manufacture. Now we hold about 15% to 25% of the loans we originate and holding those loans generates an interest income stream, which is new and independent of origination.
Our interest income went from $19 million in Q1 to $46 million in Q2. Now simply by holding a portion of those on the balance sheet, we're going to earn three times as much as for the loans we sell. There's not a lot of extra costs associated with that activity. It's just a lot of extra margin.
That was a big financial benefit that we're starting to see and we're still early. We're still in the build phase of the balance sheet. That revenue stream is going to grow over time.
The second benefit for the bank, which has not yet driven results but which will, is what we can do for the customers. We've acquired over three and a half million customers. They're very satisfied with us. 83% of them said they'd like it to do more with us and roughly that number said they'd love to have us as their bank.
We believe over time, our ability to not just solve a lending problem for them but help them manage spending and savings will create a deeper engagement and allow us to grow customer value. But it's too early for that. We haven't even done that yet.
The third benefit really did help us in ways that in retrospect is logical, but I don't think we kind of really fully internalize the degree to which it would.
The fact that we're now holding loans on our balance sheet — as it is said in the industry, "eating our own cooking" — and we are a directly supervised entity gives a lot of confidence to loan investors, specifically to banks because they know that we're held to a very high standard. They know that our incentive is not just to grow volume because revenue is tied to volume. Our incentive is to grow volume responsibly, because if we aren't responsible with credit, we're going to feel that pain directly. We will be taking credit losses, not just the investor.
The view is that fintechs don't want to become a bank because you will be subjected to more scrutiny. You're saying that in a way it helped because that scrutiny actually inspired confidence.
Yes, that scrutiny inspires confidence. I mean, half of our loans go to banks. And banks are required to treat us as an extension of themselves due to the Bank Services Act. Pre-COVID I think we had 48 separate bank exams for us because they need to make sure we're complying with the Fair Credit Reporting Act, the Bank Secrecy Act, Civil Service [Reform] Act. They have to make sure we're complying because they're responsible for our compliance. Now that we're a bank, they can be confident that we're doing that.
There's other pieces to this too. You're probably familiar that there have been some challenges to the partner bank model and some questions as to whether those loans are valid. When you make a loan, you can either be a bank, partner with a bank, or you can register for licenses in all 50 states. Every state's laws are different. They require you to frankly have a different product in many states, right? There's different interest rate caps. There's different requirements around servicing for every state.
That is really complicated, which is why people end up partnering. It allows them to have a nationwide product. If there's a question as to whether that loan is valid, loan investors have to be cautious about that too.
We're a bank. There's no question that we are the bank. We're not a partner bank. We are the bank. We sourced the loan. We assess the credit risk. We originated the loan. So there's another confidence piece there about the validity of those loans and the interest rate associated with it.
On the other part of your question of "Hey, you don't want to be directly supervised because you can't innovate." The perception of many people — a lot of people, frankly — in the banking system is that when you're a fintech, you're not regulated.
I could make a compelling argument that, because you don't have a prudential regulator that's clear, you're kind of regulated by lots of different [entities] — name a state — that is curious about your activities. CFPB, FTC. Because there isn't a clear responsible party, it's hard to even know who you're answering to and what rules you should follow.
We believe that having a clarity around our prudential regulator actually allows us to innovate because we can go to them and say, "This is what we would like to do. Can we have your feedback on this? Are you comfortable with this activity?" As opposed to just doing it and hoping that what we're doing is cognizant of all relative consumer protections.
As a fintech, your activities are required to meet the regulatory guidelines. It's not like you can ignore fair lending. You're still playing within the same kind of rule kit. You just aren't directly supervised.
When did you first start thinking about becoming a bank?
It was roughly three years ago. We basically said, "Look, we have the controls and compliance infrastructure we think that's approaching a bank." We have to because we're selling to banks. So we've already taken most of the costs. We kind of said, "We've got a lot of the costs, but we don't have a lot of the benefits." We're still paying issuing banks, or we're paying for warehouse lines.
We think we can actually innovate faster if we could control our own balance sheet and have a direct relation with the regulators.
We added all of those up and said, "You know, it reduces risks. It financially strengthens the company. It creates a more profitable and resilient model. We should seriously explore this."
Our initial path from there, once we talked it over at length with the board, was [to ask] buy or build?
On the lending side, we knew what we were doing. We felt we were pretty close to kind of bank standards. But we've never taken deposits. We have no infrastructure on deposits. We don't have the machinery around that. So we said, "Boy, if we could acquire somebody who's got that in place, it would be faster."
I'm sure you've heard about companies doing de novo [the process of building a bank from scratch]. You need to build entire teams to do work that they can't actually do until you're approved to be a bank. And they sit there until you get approved, which is years.
So the question was: Can we find a bank that's a match for us? We don't really want any branches. They need to be digitally savvy. They need to be a price we can afford. And they need to be good at digital deposit acquisition.
Well, that list was pretty short. And that's when we met the leadership team of Radius initially for a partnership. Within the first phone call, we said, "Wow, you guys are really good. You've got an award-winning digital checking experience. We're the market leader in lending online. You put these two things together and you've got a kind of an integrated, full-stack digital bank."
What was your biggest personal worry?
I had very high conviction around this being the right strategic move. In fact when the board said, "OK, you finally convinced us. What's the Plan B?" And I said, "Plan B is to execute Plan A." That's how much I believed in this.
The worry was timing to get it executed right. When, as a public company, you put out a transformational acquisition like this, which completely changes your business model, how you report your financials, how you run the company, two companies get put into some degree of limbo for a period of time.
And then COVID hit.
That was my next question.
We had to know about Zoom-based exams and all of these pieces in the middle of a pandemic. Obviously, our business went negative. We had to show the regulators that we had the capital and liquidity. We needed and we had a business plan that was achievable post-acquisition.
Was there ever a point when it looked like you might have to abort or pivot again?
No. I mean, we had to do more work to demonstrate that we're ready. We've got the control and the compliance infrastructure to handle the awesome responsibility of taking deposits, but also that we had a credible plan.
We were a very early adopter of remote work. We frankly took matters into our own hands and essentially drove a business outcome that we knew we could control.
We decided not to play last year during COVID for market share and to maximize our business. We wanted to maximize our chance of a timely approval. When COVID first started to hit, we effectively, proactively shut off all the marketing channels. We went to our investors and said, "We're pausing." Our No. 1 goal was to keep employees safe, preserve our investor returns, protect and support our members and preserve our capital.
We basically went into a corporate equivalent of shelter-in-place, if you will. We pulled way back on marketing. We dramatically lowered our expense base. We did a fairly sizable difficult but necessary reduction in force to position the company to not be burning capital, preserve our capital, lower expense base and just be able to effectively shelter-in-place while we went through the necessary exams and answer the questions, so that we could be positioned to reemerge and be successful.
That's why I say when you asked about were the results surprising, you've got to keep in mind that, in many ways, we weren't on the field last year. So what happened was we got approved for the bank and we said, "OK, we're back. Turn on the marketing. Recalibrate your models. Go back at it." We had anticipated that would take some time. We were able to do it more quickly than we expected.
Were there hurdles or headaches that were unexpected beyond COVID?
You know, I would say no, to be honest.
You don't undertake becoming a bank, obtaining a charter lightly. We had organized around this as an initiative before we announced the radius acquisition. I took my chief risk officer and I made him my chief banking integration officer and said, "Your full-time job is getting us ready for this." We were well-advised both by people who specialize in this space and legal counsel and all that to really be very thoughtful and make sure we were prepared so that we could answer any questions that the regulators have.
I'm not saying there wasn't a ton of work to do. But I would say there was nothing unexpected or that we viewed as a big curveball. COVID was the big curveball.
Other high-profile fintechs are making the same move. SoFi is acquiring a bank. Square just got a banking charter. What do you think about this trend?
And you probably know SoFi did change their approach. They also were initially going on the de novo path and changed.
You know, for the system we have, I think it's a good answer. I think it's the right answer for consumers and consumer protection. I think it's also the right answer for the regulatory framework.
The U.S. has been successful at launching an enormous amount of innovation, including in fintech. The model we have is people are often getting started by partnering with banks that make sure they've got the right compliance oversight and they understand the rules of the game and the sandbox they're playing in. But as they get bigger, I think it's a good thing for them to come into the system and be directly supervised. I think that that'll result in a stronger system.
There's a lot of talk about making changes in banking regulations. Are there specific ideas that you think should be considered based on your experience?
It's good for both the consumer and for businesses to have regulatory clarity and know where the lines are. Technology is changing quickly. Software is changing quickly. Having a framework that can keep up with those changes is important.
There's a reason why becoming a bank or acquiring a bank is difficult. You get an awesome responsibility. You are responsible for safeguarding the savings of everyday Americans. You need to show that you have the ability to be a good steward of that.
Is there a way to imagine charters that have more limited capabilities. Yeah, I think the answer to that is yes. It's a long row to hoe, but I think the answer has to be yes.
What advice would you give fintechs that have moved to get a charter or acquire a bank or are considering this path?
I think you're going to have multiple of these things in place. If you think about us, where we were on our journey, we were at scale. We had issued $65 billion in loans. We were issuing roughly $1 billion a month when we announced the deal with the acquisition. So you've got to be at a scale where it makes sense.
If you're a lending marketplace like we were and built a control infrastructure that supports your activity effectively, if you already have that and you have those costs, I think, yeah, you have to weigh the benefit.
Then, you know, you have to make sure you've got people on your management team who understand how to work in that kind of directly supervised environment. That's not the background I came from. But I surrounded myself with a mix of people from Silicon Valley and people coming out of traditional banking. You need people who understand how it works because it is a change.
I likened it to when someone tells you, "Hey, you're going to have a baby and after you have a baby, things are different." And you go, "Yeah, yeah, I got it. Don't worry. I have the room ready. I bought the crib." But until you have a baby, you don't actually know what it means. So you want to have some people on your team who've had some kids.
I'm guessing you have kids …
I do. And I very much remember thinking, "Oh, this is what they meant."