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Saturday, 5 March 2016

UK Peer to Peer Lending (PtPL) – Identifying and Managing Risk and Tips to Avoid Losses

Evaluating Financial Risk

Provision Funds

Platforms such as Ratesetter and Zopa include a provision fund to cover any expected defaults.  This is one reason why the rates of interest offered are relatively low.  The best interest on offer is between5% and 6% with Ratesetter if you are prepared to lend your money for 5 years.

This post will focus on platforms with no provision fund where defaults may directly affect the returns available to the lender.

Unsecured Loans

Funding Circle (FC) provide an estimate of the percentage loans expected to default, based on historical data for each class of loan.  However, their loans are typically for small businesses and the failure rate, in my experience, may be higher than the FC prediction and recovery rates are relatively small because the majority of their loans are unsecured (ie not underwritten by a tangible asset such as property or land).

Secured Loans at 12%

I now avoid unsecured loans and prefer platforms such as Saving Stream and Money Thing.  Saving Stream loans are almost exclusively secured against property and land while Money Thing has a broader mix of assets that also include artworks and portfolios of goods such as electronics or jewellery.  Surprisingly these sites both offer annual interest of around 12% with no fees charged to the lender.   

Minimising Losses

My tip to minimise losses is to spread your money across as many loans as possible.  Another tip is to further diversify by lending through several PtPL platforms.  You should also assess the risk associated with individual loans.  For example, if property is to be developed, is the business case for the loan realistic based on current market conditions?

Accuracy of Valuation

Something important to consider is the accuracy of the valuation of the asset.  Platforms usually quote the Loan To Value (of the asset), abbreviated to LTV, as a percentage.  So, for example, a loan for £100,000 secured by an asset worth £200,000 would have an LTV of 50%.  The lower the LTV the less likely you are to lose money due to a default coupled with a poor valuation. 

Beware works of art where the estimated value may be optimistic depending on the state of the market and current fashions.  In the case of a default, the actual value of the asset must cover money owed to the platform, the lenders capital and interest as well as selling costs, legal fees, transport costs etc.

Evaluating PtPL Platforms

In my next post I’ll explore how we can evaluate the risk in individual PtPL platforms and identify how likely they are to have loans that default where the capital or interest owed are not fully recovered.

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