Julian Cork, Landbay COO, explores the 5 points you should consider before stepping into the peer-to-peer lending world as a lender.
Theory helps you to make informed decisions about investing, and my previous posts discussed understanding the underlying assets and borrowers. It is also important to look at historic performance of both the platform and the asset class.
That means understanding expected default rates and actual default rates. All members of the P2PFA are mandated to show these on their site in a consistent fashion.
You also need to understand what the platform does with these statistics – how are they planning to deal with defaults?
The first thing to consider here is the accuracy of the projected default rates. How have they been modelled and do they consider more macro-economic factors? Stress tests help us to understand a portfolio’s behaviour as, say, unemployment rates rise or house prices fall. Established markets such as housing have many solid data sources to help here such as CML (Council of Mortgage Lenders) data. Make sure that you check the legitimacy of any cited sources.
Look to see if these stress tests are done, to what standards and if they are publicly available? Landbay recently instructed independent, Bank of England standard stress testing, and Funding Circle have also conducted stress tests.
Another credit enhancement mechanism found in some platforms is the concept of provisioning. At Landbay we have our Reserve Fund. It is important to understand how much is being put into this fund and whether or not it reflects the stress testing and expected default levels. You can look at any provisioning fund as a percentage of the Loan Book and compare this with historic performance. It is however important to remember that these are in no way ‘insurance products’ and allocation of any provision fund’s money is solely at the discretion of the platform.
So in summary, there are five things to consider when looking to lend on a peer-to-peer platform
Together these will help you to understand the level of risk that you are taking & ensure that you appropriately compensated for this risk
Finally remember that people tend to not lose money on bad risk; they don’t put money on bad risks. People lose money on good risk that goes bad – so these factors need to be continually re-assessed throughout the lifecycle of your investment.
The information contained in this blog post should not be used by consumers to make financial decisions. Consumers have a range of different financial needs and requirements and as such should always seek independent professional financial advice before making an investment decision.