The Clock Is Ticking For Lending Club

Brutal.

If one were forced to come up with a single-word description for the week that the remaining executive team at Lending Club has just lived through, we imagine “brutal” would be the winner.

As of a week ago, the “highlights” of the Lending Club’s Icarus narrative were well-known to anyone with a functioning Internet connection: An external audit of Lending Club turned up some seriously disturbing irregularities and compliance problems that ended with the founding CEO (and several other members of the executive team) either resigning or being terminated by Lending Club’s board.

Unfortunately, for Lending Club, the warm sunshine of transparency did a number on the wax holding its wings together. And the five days following the big reveal were marked by the sight of Lending Club’s share price crashing to the ground in a most spectacular fashion.

And that, as it turns out, was just the opening act.

Judging by LC’s most recent filing with the SEC, things may be about to get a lot more interesting.

A number of investors that, in the aggregate, have contributed a significant amount of funding on the platform, have paused their investments in loans through the platform as they perform audit and validation tests on their portfolios, or are otherwise reluctant to invest. The slowdown in investment capital resulting from this pause has had a corresponding effect on loan applications that we can make available on our platform for investment and, therefore, originations through the platform. If the investors’ actions continue, they may have a material impact on our available cash to the extent we use capital to invest in loans, and on our business and results of operations; however, it is too early to determine whether this trend will continue or what impact it may have on our business, results of operations, financial condition or our stockholders. It is possible that these investors may not return to our platform.

The platform death spiral looms.

The shorter version of that: For the last week, the investors have been actively eyeing the exits (which is big trouble for Lending Club — but more on that in a minute), meaning Lending Club’s number one concern is restoring that investor confidence.

In the five business days since the announcement of the internal board review described below, the Company has been actively exploring ways to restore investor confidence in its platform and obtain additional investment capital for the platform.

However, the filing also continually acknowledges that, given the rather significant hit Lending Club’s reputation has taken over the last several days, that isn’t going to be the easiest task in the world and will likely be a rather long-term effort (that comes at great, great cost — but again, more on that in a second), which may not succeed at all.

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 may significantly delay or prevent the achievement of our business objectives. In addition, the Company may be subject to litigation related to the events surrounding the resignation of Mr. Laplanche. Moreover, the Company has received a subpoena from the DOJ, and has contacted the SEC, and intends to cooperate fully with them. These occurrences could result in adverse publicity and adversely affect the Company’s brand.

So, for those keeping score at home, Lending Club’s SEC filing yesterday confirmed the following few things:

Lending Club’s radically depleted executive team is contending with a missive from the DOJ, an investigation by the SEC, a slew of litigation, an investment deep freeze, a stock price in freefall and a ravaged reputation.

And those, notably, are just the problems that Lending Club noted as specific to it.

Yesterday’s SEC filing also references coming CFPB legislation and a cooling marketplace (due to changing economic conditions) as endemic headwinds that the company had also been facing before last week’s Greatest Show on Earth officially kicked off.

A show that is now moving to Act II: The Comeback. The biggest question about Act II: Is it even possible to stage it?

So, What Happens Now?

If there is an upside to any of this — and, admittedly, upsides from Lending Club’s point of view are likely in short supply — it is that bad news is likely all out by now. There is likely no shoe left to drop.

The phrase “the Company’s internal control over financial reporting was ineffective due to a material weakness and, therefore, the Company’s disclosure controls and procedures were also ineffective” appeared throughout the document, as well the steps Lending Club is undertaking to rectify those material weaknesses.

So, upside: problem acknowledged, problem being addressed.

But those solutions are likely to come at great cost in any event. Plus, the filing makes clear: Lending Club is now considering a very large reset on its platform in the event that it can no longer attract investors to buy out its loans in securitized form and will have to begin funding the loans it underwrites itself.

We are actively exploring ways to restore investor confidence in our platform and obtain additional investment capital for the platform loans. These efforts may take a number of different structures and terms; including equity or debt transactions, alternative fee arrangements or other inducements including equity. These structures may enable us or third-parties to purchase loans through the platform.

There is no assurance that we will be able to enter into any of these transactions, or if we do, that the final terms will be beneficial to us. If our attempts to secure additional investor capital to meet platform origination volume are not successful, we likely may need to use a greater amount of our own capital to purchase loans on our platform compared to prior periods, particularly in light of regulatory commitments to fund loans solicited by direct mail and other contractual purchase obligations.

Lending Club’s design — and, up to this point, main advertised strength — is that it evaluates borrowers and arranges loan underwriting but does not actually carry any loans on its balance sheet. That is the “genius” of the online lending marketplace. Lending Club found a way to make money on lending via fees on the loan but never actually had to carry any of the risk of the loan, which was bonded out and sold.

But that only works if someone wants to actually buy the debt, and it is unclear that Lending Club will be able to convince investors they feel comfortable doing that. Which means, at least for the time being, Lending Club will be assuming its own risk and losing a fair amount of money doing it, as those networks effects the firm once touted start working in reverse.

And, because it never rains but it pours, this situation is only realistically sustainable for a very short period of time, given that Lending Club also needs to keep its doors open and its lights on. According to the filing, that time period is about a year long.

Our short-term liquidity needs generally relate to our working capital requirements. These liquidity needs are met through cash generated from the operations of facilitating loan originations. If the recent pause in investor funding on our platform, as described above, continues, cash generated from facilitating loan originations could decline, in which case we may need to use our cash on hand, which was $583.8 million at March 31, 2016, to meet our working capital needs … We believe based on our projections and ability to reduce loan volume if needed, that our cash on hand, funds available from our line of credit, and our cash flow from operations is expected to be sufficient to meet our liquidity needs for the next twelve months. 

So, 12 months — the clock is officially ticking.

It’s Always Darkest Before…

There is an old and favored expression of anyone in a tough spot: “It is always darkest before the dawn.”

In 2004, John McCain famously amended that expression to say, “It is always darkest before it gets pitch black.”

And while the the second iteration is darker, it bears mentioning that the Icarus story ends when he hits the water. There is not a second part where he swims to shore and opens a successful snorkeling business for tourists to the Greek Isles.

Comebacks are particularly hard.

But Lending Club is certainly ready to, at least, come out swinging. Its latest SEC report also noted that, despite the recent unpleasantness, the external audit also confirmed that the irregularity was rare.

Excluding the $3.0 million of loans noted above, the advisor observed that 99.99% of the remaining loans display either no changes or changes explained by the normal course of business.

The question is: Will 99.9 percent legit status be enough — with the new control and compliance measures — to lure investors back to the platform in the year or so it seems Lending Club has do it in? And, even if that works, will it be enough to allow the firm to carry on through what looks like a very active — and expensive — litigation schedule in criminal and civil court?

Suffice to say, it won’t be easy.

And the clock is ticking.