Here is a small FAQ section that hopefully answers some of the basic questions that a new P2P investor faces. The FAQ is not complete so if you have other questions please let me know in the comment field below. Then I will do my best to answer.
- Credit institutions (loan originators)
- Online platform/marketplace providers
- Investors (you and me)
The concept is rather straightforward. A borrower gets a loan in a credit institution. The credit institution offers part of the loan on a marketplace while keeping a part for itself, commonly referred to as the "skin". Many investors (=crowd) each buy a small share of the loan via the marketplace. As the borrower pays of the loan including interests, a portion will go to the investors. This is repeated until the loan is paid off.
Terms & Conditions
Before pressing register, remember to go through the terms and conditions. Most of the information seems to be copied from one platform to another but there are small variations. I usually check for descriptions of how platform and loan originator insolvencies are handled and what kind of exit strategies the platform provides. But take your time reading it through so you will not be surprised at a later stage. Now you only need to find out how much you are willing to invest/loose.
There are several risks when investing in p2p. Here are 4 of the major risks:
- Loan default
- Loan originator bankruptcy
- Platform bankruptcy
- Lack of transparency
This happens all the time, and eventually you get used to it. If you have invested in loans with a buy back guarantee (BBG), the BBG should kick in. Here we are assuming that the entity providing the BBG is financially healthy. Sometimes there is no BBG but then the loan originator/platform might still be able to collect a portion of or the full amount of the loan. If not, then your money is probably gone for good. You can minimise the risk of a loan default by investing in less speculative loans. However, they usually also come with a lower interest.
So it might be tempting to put your money in a high risk 20-25% interest loan. Still, this doesn't really matter if you do not see you money again. In this respect, a 10% interest loan at a lower risk backed by a financial sound loan originator with a BBG might be a better option.
Loan originator bankruptcy
This also happens sometimes. There have just recently been two examples on the platform Mintos:
I happen to be oh so fortunate as to have invested in both of these loan originators so I will be watching the recovery process closely. So far I have not seen any money but it's still early days so let's see what happens. The loan originators were rated C+ and C on Mintos at the time of the announcements. On a scale from A to D, a C is not great. Nevertheless, it still doesn't entirely reflect their poor financial situation. After this Rapido Finance has been downgraded to a D. Interestingly there are plenty of other lenders with a similar rating on Mintos as shown below.
Should you be wary of these loan originators as well? Perhaps, but I think you should rather find alternative rating sources instead of being entirely dependent on Mintos. Next time it might be an A rated loan originator that is in financial difficulties. By then you know that the Mintos rating system is just guidance, maybe even bad guidance. For loan originators on Mintos it is possible to find other rating sources. For smaller platforms this might not always be the case. If you do find another rating source, be aware that it might not reflect current state.
There have been a few recent examples of platform bankruptcy including the two British platforms Funding Secure and Lendy. As of November 2019 both platforms are still in the administration process. Only when this is finalised, we will know how much was repaid to the investors. In any case, you do not want to put money in a platform that might soon go out of business. This is usually not a good investment, as the process of getting your money back partially or in full, can be a rather lengthy one. It is therefore important that we learn from these cases and pose the question:
Is it possible to predict platform bankruptcy?
Lets look at an important financial KPI for p2p platforms, the loan volume. If the loan volume is very volatile, this could indicate business instability. However, the level of volatility also depends largely on the type of platform and its size. For a large, consumer based loan platform you would expect a steady flow of loans and hence low volatility. For a small, project based platforms you could anticipate a much higher volatility. If your experience with the platform is otherwise good, this might be perfectly acceptable.
Of course if the overall loan volume trend is negative, this is not a good sign. Below we will take a look at the two platforms Funding Secure and Lendy and their loan volumes during the last two years of operation.
Funding Secure was a project based platform, mainly dealing with the purchase and development of property. It was put under administration by the FCA in October 2019 due to insolvency with 80 M pounds of outstanding loans.
Lendy was also a property based platform which was put under administration in May 2019. Back in 2017 it had a monthly loan volume > 25 M euros and was at that time even bigger than Mintos.
All three graphs show a general decline of the loan volumes, which is easy to see in hindsight when you have all the data. It is however far more interesting if you can use it as a predictive tool where you do not have all the data and the bankruptcy has not occurred yet.
For Lendy, there is a steep decline at the beginning which might indicate a little instability. The short term instability is further supported by a long term decline (biannual/quarterly graph). This is an indication to investors to stay away or sell their loans. Some platforms offer an an exit option (selling back to platform) or a secondary market (selling to other platform users).
For Funding Secure it is harder to spot a general negative trend until at the very end. Or at least the quarter before and then it might be too late. This might be a product of fewer data points, which is also a point to consider, as it reduces the transparency of the platform and thereby increases the risk. Nevertheless, the approx. 50% drop (biannual) 1.5 years ago could be an early warning.
Lack of transparency
It is a common perception in the p2p investor community, that p2p platforms should do more to improve transparency. The lack of transparency is probably related to the fact that p2p lending is a fairly new, unregulated industry.
This means that there are very few, if any, requirements to financial transparency. Hence, the level of information provided by the platforms themselves can be quite limited. However, the p2p platforms also know that transparency is a way to build up investor confidence. Investor confidence is a key parameters for the platform to succeed, that and competitive interests. That is also why you sometimes have several platforms that appears to offer the same product but who are perceived very differently in the p2p community. This might be directly correlated to the level of financial transparency but also track record, reputation etc.
Sometimes the financial information is directly disclosed by the platform itself (preferred method). At times it can be obtained from other sources such as company databases/registries.
Diversify. This is and probably has always been the best investment advice you will get. Diversify across loan types, loan originators, platforms, geography, investment markets etc.
Find reliable sources of information and read as much as you can. Here I have listed some of my favourite sources of information.
Some blogs are generally just one fairytale story after another about all the positive things about being a p2p investor. As you have probably already figured out, I would be a little wary of these. If the blog you're reading sounds like a sales pitch, it probably is. Some blogs do more than just appraisal such as describing the different risk aspects of investing. Pick those. They are worth an in-depth study. And again pluralism is your friend so the more the better until you have at least a handful of trusted sources. I have listed some of my favourite sources here.
You will quickly see that whereas some platforms only appear on one or two of the blogs some platforms are more often recommended. And as you have correctly guessed, these are the ones you should check out as a new investor.
Diversification via Autoinvest
Some platforms offer a diversification setting which allows you to diversify via one single autoinvest. The downside of this is that you cannot alter the interest rate so it is aligned with each individual originator. Secondly, if something goes wrong e.g. due to an error in the settings, it can impact your complete investment portfolio, thereby putting your investments at much greater risk. Hence, multiple autoinvest functions should always be your aim.
A fairly reliable source of information is an audited annual report. However, many platforms do not provide this level of financial transparency and a year is also a long time in a fast moving industry. Hence, biannually or quarterly financial statements are often more insightful glimpses of the current financial state. Keep in mind though that these statements are generally unaudited.
Besides financial statements, other good sources of information are company registries. Often they provide basic information such as taxation and tax debt but sometimes they also provide indicators on aspects such as profitability, equity and liquidity. Sometimes they even contain financial reports but this tend to come at a fee. Besides, the in-depth information is most likely in the platform's local language so some translation skills or tools might be required.