Lifting the hood of an online lending business


One of the rallying cries of new companies trying to supplant old banks is “transparency”.

While in the past, it is said, banking was opaque and shrouded in mystery, in the future the financial system will be easier to inspect and therefore crises will be more effectively prevented.

There are many flaws in this reasoning, and of course we put it crudely, but one consequence of this quest for transparency is that many online lenders that have sprung up since the global financial crisis are making their loan data readily available to investors and to the public. to the big one. The data is heterogeneous between lenders – hence the secondary industry of data analytics companies – but the information is still there, loan by loan, if you can bother to take a look.

Most companies don’t provide as much detail as Ratesetter, an online lender in the UK and one of the big three peer-to-peer lending companies in the country. Ratesetter not only gives you a loan-by-loan breakdown of the credit it has given, but it also provides a unique borrower identification number, which means you can build a picture of some of the great loans the company consented.

Before we continue, it’s worth recap what we know about Ratesetter so far. Despite the “peer-to-peer” label, the company has many nuances of traditional finance. For example, it runs a provision fund designed to protect investors against losses, but when they run out, investor funds are pooled and disbursed on a pro rata basis as loans are depleted. It also makes a significant amount of loans to other lending companies and until recently did maturity transformation.

So what’s in his loan book? Well, you find a good number of very large unsecured loans to individuals, the largest of which are apparently “mislabelled”, and a reliance on a small number of commercial clients for a good portion of its loans.

For example, the biggest single loan ever granted by Ratesetter was a £1.6million loan last November to a private individual, who pays 6.8% pa for the money. The loan is classed as a ‘business loan’ and is ‘unsecured’ – if that person left town, 9% of Ratesetter’s £17.6m provision fund would be wiped out.

Then there is the total borrowing of £1m that an individual accumulated throughout 2015, starting with a loan of £125,000 in February at 3.2% and ending with a loan of 50,000 £ in December at 5.9% – the weighted average rate is 4.66% on 14″ business loans”, all “unsecured”, and for most loans in fine, i.e. none payment until the due date.

These types of large loans are not uncommon – you find around £66m of loans over £50,000 to individuals, the vast majority of which are unsecured. That’s about 6 or 7% of all the loans Ratesetter has ever made. Of this amount, around £35m is made up of over £100,000 in retail loans, although Ratesetter’s credit policy caps its retail loans for commercial purposes at £100,000 (the standard ceiling consumer loans is £25,000).

A spokesperson for Ratesetter said “unsecured” in its loan book may mean that a security “is simply intangible.” Thus, this loan of 1.6 million pounds sterling includes an obligation on the company of the borrower and “a personal guarantee of the main shareholder”. It’s also mislabeled – the spokesperson said it’s actually a limited liability company. Loans of £1million to a private individual last year were also secured by a debenture “and debtor insurance was also in place”, they said. Loans that exceed its credit policy go through their credit committee, which meets twice a week, the spokesperson added, and are reviewed again in their “monthly portfolio review”.

Elsewhere, you can find wholesale car loans. The largest is a £111,500 loan made in December 2014 at 8.7%, again unsecured but, according to Ratesetter, again mislabelled. It was actually a loan to renovate rental properties. “Our credit committee was comfortable with the risk and return profile of this loan,” the spokesperson said. There are other car loans available for up to £76,000, while most UK banks will do between £25,000 and £60,000 – perhaps underserved luxury car buyers are turning to P2P?

Additionally, none of Ratesetter’s auto loans are secured by the vehicle. “We lend to the individual, not against the vehicle,” said the spokesperson. “They’re just unsecured consumer loans, which is a very normal way for someone to borrow and then buy a car.” They added that nearly 99% of their car loans were below £25,000 and the average loan was just over £6,000.

Ratesetter will also give you a substantial home improvement loan if your house needs sprucing up: £112,000 was lent to one person in June last year at 8.9% for these purposes, again unsecured . A spokesperson said it was a loan “to an individual for business purposes”.

On the corporate side, two borrowers in particular stand out, accounting for almost £55m of Ratesetter’s loans in 2015 out of a total of £516m. Both lend businesses themselves. The former borrowed £37million, mostly for loans against hire-purchase agreements, which suggests a car loan company. The second borrower is more curious, totaling £17million from almost 5,000 consumer loans. Instead of a full-fledged borrower, this second company is more like a channel for Ratesetter’s personal loans – something that would fit in with Ratesetter’s partnership with Giffgaff, the mobile phone network.

There are a few conclusions we can draw from all of this. The first is that transparency, while an admirable goal, is not always in the best interest of a company itself – at some point, which Ratesetter has no doubt reached, you start giving your competitors a plan for the inner workings of your operations. Imagine having this level of loan detail from a bank.

Another point to consider is that by themselves these details do not tell us whether these loans are responsible or irresponsible, or whether investors are being properly compensated for the risk they are taking. To date, Ratesetter doesn’t appear to have had any significant issues with defaults – although he obviously grew up in a very benign credit environment.

The lending book can’t be taken at face value either, with all the mislabeling that seems to be happening. Data isn’t really useful if you can’t be sure it accurately reflects the truth of the situation. Transparency counts for very little if it is not accompanied by accuracy.

But more broadly, all of this makes it quite difficult to understand what kind of company Ratesetter really is. It may be obvious to other people, but we don’t know what counts as a “typical” rate-setting borrower or where the core competency of the business lies. Maybe it’s equally good for all types of lending — it’s possible, but it’s a harder sell than “we’re really good at this.”

The last thing to remember is that Ratesetter and its rivals are all awaiting approval from the Financial Conduct Authority, after which they can take out their loans in an ISA – a popular tax-free savings product offered in the UK. The government has moved to regulate peer-to-peer lending under a relatively light set of rules governing electronic lending platforms. But hopefully it’s now clear that peer-to-peer lending isn’t a thing, and companies that call themselves ‘peer-to-peer’ are actually involved in a diverse range of what is traditional finance under a different name.

Related links
Peer-to-peer maturity transformation – FT Alphaville
The curious state of ‘peer-to-peer’ lending in the UK – FT Alphaville
It’s the lenders all the way – FT Alphaville

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