Peer to Business Lending
Alternative Finance Sector Report - November 2014
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PEER TO BUSINESS LENDING
ALTERNATIVE FINANCE SECTOR REPORT
PUBLISHED
November 14
AUTHOR
Luke Jackson
Samantha Goins
Gross returns range from 5% per year for very low-risk (A+ rated) opportunities to 15% for high-risk (C-) opportunities. Both low and
high risk opportunities can have tangible security from some platforms which means that a significant risk of default can be mitigated
with a substantial expectation of recovery of all or some of the capital after the sale of the security. There are extremes which sit
outside of this range of returns but which are far less common. Very low and low-risk investments have returns that exceed those
available through cash deposits or government bonds, whilst high-risk opportunities can match (and in many cases) exceed most
returns from equities.
Investors must consider their investment aims and decide where they fit into this spectrum, and select opportunities which are
appropriate for them.
DEFAULTS AND BAD DEBTS
Default rates and bad debts are an important consideration and can have a major impact on returns. Due to the relatively
immature nature of the market, information to support defaults and levels of bad debt is hard to come by. Many platforms
work to a ratio or percentage of loans which they believe will fail within each risk rating band. For example, on average 8
out of every 100 C- rated loans will default, resulting in a (potential) complete loss of capital. In order to minimise the risk of
a complete loss of capital, some platforms will have a protection/provision fund in place or will only accept loans which are
asset backed.
Asset backed loans can dramatically reduce the risk of a complete loss, providing the value of any assets backing the loan is
sufficient. For example, if the loan was for £100, but only £80 can be recovered via, say, security; there would be a loss of £20
(20%). This is called the Loss Given Default.
Investors can minimise the risk of loss by having a number of loans as part of a portfolio. The more diverse the portfolio of
loans, the higher the possibility of predicting the number of loans that will default. This is called the Probability of Default, a
percentage figure showing how likely the business is to default.
The Loss Given Default will vary over time as the loan is repaid in instalments and the value of secured assets fluctuates. In
ideal conditions the value of the security should be very strong and the Loss Given Default should remain very low or ideally
£0. However during poor market conditions the value of the security could drop dramatically and it might only be possible to
recover 60% of the security’s initial value. This is unlikely to be enough to repay the loan, unless the security was initially worth
significantly higher than the value of the loan.
For example, where the loss is £20 if the loan defaults, the portfolio contains 100 similar loans and a Probability of Default
across the portfolio of 15%. 15 out of the 100 loans are expected to default, with a loss of £20 on each loan.
Outstanding value of the loans is £100 x 100 = £10,000
Number of loans that are likely to default is 100 x 15% = 15
Loss from the loans that are likely to default is 15 x £20 = £300
Expected Loss on the whole portfolio is £300 / £10,000 = 3%
On 11th August 2014 Funding Circle announced on their blog that they expect recoveries across all loans defaulted up to 30th
June 2014 to recover a minimum of 34p in the pound. With more recent loans (between 1st January 2014 – 30th June 2014) they
hope to recover up to 40p in the pound.
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This compares to traditional lenders which, according to independent research,
would expect to receive between 28p-42p on a secured business loan and 1p-3p on unsecured business loans (without a
personal guarantee) once a business enters administration. Assetz Capital, by way of example, has a current expected loss rate
of just 0.12% across loans to date (October 2014) due to the low loan to value on tangible security across the loan book. This
represents a recovery rate expected of 85% on the defaults to that date of 0.85% of total cumulative lending.
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