Lending Club’s Auto Lending Pivot

Trying something new and different is both one of the hallmarks of innovation and a typical option when a company finds that the same old thing just isn’t quite working anymore.

With that as a backdrop, it is not at all unusual for Lending Club to be trying something new — like car refinancing.

With originations down, investor interest waning and high-ranking executives jumping ship (or, in some cases, being pushed off when ethically questionable behavior was discovered), things have been a little tough at Lending Club since the beginning of May. Wall Street has unquestionably noticed, too, as the firm’s stock price has struggled to get (and stay) above $6 for the last several months. Lending Club’s share price yesterday (Oct. 31) closed at $4.93, which, in fairness, was an improvement over the $4.73 it started at.

A reset button is clearly what the doctor ordered here, and last week, Lending Club trotted out at least one such option: moving its debt refinancing model — heretofore mostly applied to consumers looking to consolidate credit card debt — and applying it to auto loans.

“People think a lot about refinancing their mortgage, but they don’t think much about refinancing their vehicles,” Lending Club Chief Executive Officer Scott Sanborn noted in an interview about its latest expansion.

And by the numbers, Sanborn is right. There is about $1 trillion (with a “T”) in auto debt floating around out there in any given year, and only about $40 million of it is refinanced. So, $9.6 billion in auto refinancing is the latest untapped source of value waiting for an innovator to tap into? Right?

Well … it is possible that LC has found a way to get its groove back and the beginning of something beautiful. But then again, there might be a reason that so few car loans are refinanced each year and that no one bothered to do the math since there was no real business opportunity to give anyone an incentive to get out the calculator.

We’ll let you decide.

How It Will Work

Lending Club’s pitch is pretty simple. According to its CEO: “You probably have a car loan. You probably have a lousy interest rate on it. Let us fix that for you.”

On that point, he is likely correct. Auto lending levels have been spiking for the last two years — particularly among subprime borrowers — as lenders have begun loosening up standards to auto underwriting. In the year that ended in June, only 5.2 percent of car loan applications were rejected, according to research from the Federal Reserve Bank of New York. That very nearly slices the previous year’s rejection rate of 11.1 percent in half.

But just because a market is big doesn’t mean it is necessarily accessible, and car refinancing has some distinct troubles. The first is that the borrower pool these days is looking less strong. Subprime borrowers are falling behind on car payments at the highest rate in six years. And the market is competitive. Lenders have lowered prices and loosened their standards in an attempt to attract buyers in a competitive market.

Not quite any used car owner can refinance — but almost any. The car in question must be less than seven years old, and the loans are capped at $50,000 so consumers who still owe $150,000 on their Bentleys are out of luck. The service will only be available to California residents, but loans can have terms of up to six years and can carry annual percentage rates between 2.49 percent and 19.99 percent (though, if 19.99 percent on a car loan is a better deal than a consumer had, well, perhaps they should consider working on their credit report before doing any more borrowing).

“This is a pivot off of defense,” Sanborn said.

And it is certainly a proactive step.

But is it a correct one?

Some Concerning Issues

Part of the reason car refinancing is rare is that, unlike credit card debt, double-digit interest rates on auto loans are not common for anyone but deep subprime borrowers. The average rate on a car loan for a prime or near-prime borrower is around 5.32 percent, which a very narrow needle for Lending Club to thread to undercut the original interest rate and still make a profit.

And Lending Club, notably, claims that an analysis that it conducted using data from credit reporting company TransUnion found its auto loans would carry an annual percentage rate between one and three percentage points lower than a consumer’s current loan. Consumers might greatly enjoy a car loan at 2.32 percent, but the economics for Lending Club remain a bit unclear.

Also, Lending Club’s past attempts to branch out of consumer debt consolidation have met with mixed success. An attempt to start a B2B lending business never quite took off. As of the first half of 2016, such loans accounted for only around 9 percent of Lending Club’s total volume, or $420 million.

And then, there is the auto lending market itself, which is on fire but is perhaps not so healthy.

Prices of used cars up to eight years old are down 3.6 percent in the year’s first nine months, according to J.D. Power. It’s the first “material” decline in prices since 2008, said the company’s Larry Dixon.

“Losses are going to go higher. There’s no question about that,” said Hylton Heard, senior director at Fitch Ratings.

And the big auto lenders, like Ally Financial, Capital One and Wells Fargo, have all noticed. Ally wrote off an annualized 1.37 percent of its loans in Q3, its highest chargeoff rate since at least the end of 2012. Wells Fargo — the nation’s largest auto lender — has actually decided to ease off the gas some and dropped its originations by 2 percent in Q3.

Plus, cars have a refinancing issue that houses — the type of secured loan consumers are more likely to reset — do not. Houses (in general) get more valuable. Cars (almost always) don’t. And a car — though hard to walk away from when the loan gets too out of control — is not as hard to walk away from as the home one is currently living in.

So, What Is The Final Analysis?

Lending Club has made an undeniably bold move and is being proactive.

But whether auto loans were the place to start? Well, the LC team had better hope that the auto lending industry isn’t about to enter into an expensive subprime crisis of its own.