One of the main concerns investors raise with LendingClub is not the risk of borrowers defaulting, but rather the risk of LendingClub going out of business. The prospect of LendingClub going out of business is not only possible, many would say it is likely. The fact of the matter is, LendingClub continues to lose money each quarter. Despite the fact that they have been steadily increasing the volume of loans issued nearly every month since inception, for some reason LendingClub has not found a way to be profitable. Their most recent annual report shows that LendingClub lost $10.25 million during the year ended March 31, 2010. This trend had not been corrected as of their most recent quarterly filing for the quarter ended December 31, 2010. This filing showed a net loss of $2.89 million for the quarter. They have already received tens of millions of dollars in venture capital funding, however, one has to assume that if they cannot become profitable soon it will become increasingly difficult to obtain follow on financing. Additionally, they have millions of dollars worth of secured outstanding debt that is senior to our investments in borrowers' notes.
Due to the significant risk of bankruptcy, it is very important for lenders to know what will happen to their investments should LendingClub go out of business. Unfortunately, there is no clear cut answer. In order to attempt to understand what would happen in the event of a bankruptcy, it is important to understand exactly how the lending process works and understand the flow of funds. When a borrower receives a loan a company named WebBank sends issues the loan to the borrower. Then, WebBank sells the loan to LendingClub at approximately face value. LendingClub uses the the money that lenders have invested in the specific loan to buy the note from WebBank. However, LendingClub has legal claim to all of the actual principal and interest payments received from the borrower for the loan because they hold the note. Investors are essentially making a loan to LendingClub, not the borrower, that is "secured" by the revenues from the note that LendingClub purchased from WebBank. I put "secured" in quotes because there is actually no legal or moral obligation of LendingClub to repay the lenders loan. It is simply their policy to do so. Therefore, since the lender has no legal claim to the revenue stream provided by the borrower's loan payments it is unclear that the lender has any claim to any assets or revenues in the event of a bankruptcy.
Initially, LendingClub made it seem as though a bankruptcy would have little impact on lenders. They advertised the fact that they had a 3rd party ready to step in to service loans should they become unable to do so. They also said that they only used member loan payments as security for a very small amount of debt and that most creditors had no claim on member loan payments at all. This language implied that lenders did have claim to these revenues, or at least seniority to other creditors with regards to these revenues. This language has been removed from the most recent prospectus so it is likely that LendingClub attorneys no longer believe this to be the case. The new prospectus essentially says that LendingClub does not know who would have claim to any of their assets or revenues in the event of a bankruptcy.
According to the new prospectus there are a few things we can infer. In the event of a bankruptcy LendingClub would likely stop making all payments to both creditors and investors until they had clear direction from a judge. This will include loan payments as well as distributions of available cash which is held in an account "in trust for" the lenders. Then, there would very likely be an extended court battle between all parties who had an interest in LendingClub. This could take years and be very costly for everyone involved. LendingClub has refused to give any guidance in their new prospectus as to who would likely ultimately have claim to any of their assets, including member loan payments.
It is very likely that in the event of a bankruptcy all lenders would lose a portion of their investment. Even if it is determined that investors do have a legal claim to loan payments, it would be a very costly legal battle to reach that decision. However, one comforting factor is that it does not appear that LendingClub's outstanding debt is significant in relation to the amount of outstanding member loans. As of their most recent quartely report there were $122.5 million of outstanding member loans. However, they do not have nearly that much in debt. Therefore, even if lenders were the last in line to collect from LendingClub, they would still stand a good chance of receiving a significant portion of their investment.
At this point it seems as though LendingClub is not certain what events would transpire during a bankruptcy. We really don't have many options other than to wait for additional guidance. Also, we can continue to monitor their financial statements to make sure they have enough cash to continue operations which would decrease the likelihood of a bankruptcy in the near term. Stay tuned for future updates.
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