Ratesetter

qpop

A well-respected user on here (whose name escapes me) has written some very well thought out risk warnings on "P2P lending". Hopefully someone with a better memory than I might point you in the right direction.

Essentially this is a far riskier investment than people may at first realise. Unlike OEICs, Investment Trusts, etc. I don't believe your money is covered by the FSCS. That significantly increases counter-party risk, as your trust is essentially vested entirely in the intermediatry (in this case, Ratesetter) and if they disappear, or change their policies, for example, you have very little recall.

I think the above is more reastically the reason MSE stays away from embracing this kind of investment, and has nothing to do with "short-circuiting the banking system". It is a fairly high-risk investment, with opaque charging structures, that is essentially unregulated. MSE tends to shy away from much in the way of "risk" investment.

If you look at other types of investment on the (fuzzy!) risk/reward spectrum, there are better opportunities for growth.

JohnRo

Ratesetter have a very clearly stated charge, they earn 10% of any interest earned by lenders using their service.

Borrowers are required to pay an additional creditworthiness fee which is paid into a provision fund.

And that's pretty much it. The rest is up to the lenders and borrowers.

The cornerstone of the business model and future success is the job ratesetter get paid for, vetting borrowers, which according to their website and my experience is very impressive. They aren't (unlike ZOPA) entertaining risky borrowers which is perhaps why the business is growing slowly but steadily and the default rates are close to zero.

Don't mean to sound like a company spokesperson but the bases are covered as far as I'm concerned. Even if the company did disappear, the loan agreements are legal binding documents and the provision fund offers a substantial safeguard and the potential for bonus returns to investors in future years.

I do agree the rates are probably a little low but they're set by the lenders themselves, not ratesetter, so there is no cause for anyone to complain on that score.

Babycakes

Why the heck are the lending rates so low on Ratesetter? I mean 4.3% for a monthly rolling contract is lower than inflation before fees and taxes! Furthermore, some of the payday loan companies are charging thousands of percent a month!

easteregg_2

Babycakes wrote: »

Why the heck are the lending rates so low on Ratesetter? I mean 4.3% for a monthly rolling contract is lower than inflation before fees and taxes! Furthermore, some of the payday loan companies are charging thousands of percent a month!

The monthly rolling contract is currently yielding around 4.5% (after fees but before tax and bad debt) but lenders are able to realise their funds at short notice. The 36 month loans on RateSetter are around 6.7% (after fees but before tax and bad debt).

While the APR's on payday loans are in the thousands of percent, a very large proportion of this APR is due to the fixed costs of processing an application.

qpop

At the same time, though, Invesco Perp Corporate Bond yields 5.6% gross, inclusive of fees, exclusive of tax. It is also "instant access", although the capital value of your funds would fluctuate.

http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=PPPB&univ=U

You also spread the risk across many companies, and have the benefit of FSCS protection if Invesco Perpetual suddenly decided to close the fund and run off with the money.

I really don't see the appeal of crowd-sourced lending. In theory it's great, in practise it's fraught with risks.

JohnRo

Horses for courses surely, the two don't really compare in any way. The most obvious being Ratesetter returns are (almost) entirely immune from the fickle stock market and it's many convulsions as is the capital used to get that return. Ratesetter lenders also know their money isn't funding fat cat banking failure bonuses.

I'm also intruiged... what exactly is it about their historic 0.18% default rate (0.09% currently) that you perceive as fraught with risk given the provision fund could comfortably handle a 40 fold increase in the current default rate at existing levels. An increase like that would be utterly bizzarre unless they start employing chimpanzees to approve borrowers.

The whole assertion of greater risk seems predicated on little more than an a fantasy that the company are about to stuff all the cash in a suitcase and clear off to South America.

qpop

Yes, but what if they did? Like I said I'm echoing the very sensible hypotheses someone else wrote about here at great length.

Corporate bonds aren't stock-market linked, and in fact they don't tend to follow the same peak/trough cycles.

I just think the whole system is painted as being far lower risk than they are.

qpop

jamesd wrote:

Lets ignore those simplest high risks of no regulator for lending and no FSCS protection for the moment and move on to discussing lending risk.

I recommend that you start by reading about the role of credit ratings agencies and banks selling packages of mortgage loans in the market meltdown in 2008. You know, the main cause of the market collapse in 2008 that's still causing trouble today.

A major risk of Zopa comes from the parties who are doing the credit rating of the packages of loans and who are selling them and what that implies for risk. Lets compare:

Packages of mortgage loans: one of three independent credit rating agencies assigning the credit rating.

Zopa: Zopa assigns the credit rating.

Packages of mortgage loans: the banks selling the loans are independent of the ratings agencies, except for paying them.

Zopa: Zopa is doing the credit rating and selling the packages of loans.

What that combination does is introduce a conflict of interest. The body doing the credit rating is also the one that makes money from selling the loans. The more loans they sell, the more money they make. Even with the independent credit ratings agencies the mortgage loan system failed, perhaps in part because the sales people were paying the ratings agencies, so the agencies had an incentive to give good ratings.

Now it'd be nice if this was only a theoretical risk, but sadly it isn't, even in the UK. A couple of years ago one of the UK lenders was forced to fire some quite senior staff after they were found to have breached their own lending guidelines to meet lending targets. That wasn't Zopa. But it is part of the risk that lenders take when using Zopa.

That's OK so long as Zopa is perfectly ethical and all employees there always follow policies perfectly, or Zopa acts correctly to rectify mistakes, which are inevitable in any business. It's part of why I take any case where Zopa may act in a way that is not 100% ethical very seriously, because lenders at Zopa are 100% reliant on Zopa acting ethically.

If you look at just the performance of borrowers in the past, you're missing the big picture: the risk that Zopa might do less well in the future, because it's a structural conflict of interest in the Zopa lending system. Well designed systems either avoid those or tend to have external controls in the form of independent auditors to try to control them.

Or without external controls, Zopa could pay a significant portion of lending losses out of its own pocket, to better align its financial risk with the financial risk of lenders. That is one of the controls that been suggested for the mortgage markets, that those who make mortgage lending decisions and those who resell them be required to keep some of their own money at stake, so they aren't incentivised to sell, make their money, then pass on all of the risk.

That's also one of the other structural risks of the Zopa setup: Zopa gets its borrower fee paid for out of funds provided by lenders (but to be repaid by the borrower), even if the borrower never makes a single payment. A more risk-limiting structure would have Zopa getting paid only when the payments are made, so that Zopa also suffers a direct financial loss in such cases, beyond the costs of debt collection, which are charged, at least in part, to the borrower, should they be traceable.

Even if Zopa was to act perfectly for 20 years, a change could cause that to fail badly in the future. It's where external controls and auditing of lending standards could come into play and perhaps in the future Zopa will have some system for that, where the system is arranged so that the auditing party has a fiduciary responsibility to investors, not to Zopa. If that ever happens it'll be a significant step in reducing the investment risk associated with Zopa. It will still remain high risk because it takes time for controls to detect failures but it would be an improvement.

Zopa argues that it has an incentive to keep defaults low because they discourage lenders. Lets consider the merits of the assertion. Back in 2008 lending the default rate has so far been around twice the rate given at the time the loans were made (not visible on current data because Zopa changed to report against current rates). Yet we have you writing that defaults have been low so far, without mentioning the time when they were roughly double the rate specified. And we know that Zopa is not generally short of money to lend, but of borrowers, so the incentives are all wrong for the actual shortage - Zopa could lose a lot of potential lenders without it affecting business.

It is of some potential effect as a control, because I mention it here sometimes. But that's just one individual on a message board, hardly significant. For it to be a truly effective control it would need to be mentioned at least periodically in press stories about Zopa. And that doesn't seem to happen, certainly not enough to discourage lenders, as your writing here shows and as the excess of money available to lend also shows.

If you're interested in a discussion of risk we could discuss it more because I think it's an interesting subject that isn't really discussed enough in the P2P lending field. But for now I'll just write "high risk" as a summary because that covers it well without getting into a long essay like this one.

There we go, found it. - Just replace Zopa with Ratesetter.

JohnRo

For those interested, Ratesetter are a founding member of the p2p lending association.

http://www.p2pfinanceassociation.org.uk/

easteregg_2

JohnRo wrote: »

For those interested, Ratesetter are a founding member of the p2p lending association.

http://www.p2pfinanceassociation.org.uk/

The other members are Zopa and Funding Circle. I've personally lent money with all three and I would rate them all highly.