My First Loan Default

After almost a year of investing I’ve just experienced my first Peer to Peer loan that has defaulted with the borrower filing for bankruptcy.  I always knew this day would come, however I believe I’ve prepared well to wear whatever the final outcome may be.  The loan in question comes from my first investment platform TruePillars.  While this maybe my first default, having directly invested in over well over one hundred loans across multiple platforms, I’m confident I will experience it again. 

This particular loan I actually only purchased a few months ago on the secondary market and only received a couple of payments before the default.  While this is disappointing, we need to put this in perspective.  The investment only made up 0.2% of my TruePillars portfolio of just over one hundred loans and the total outstanding value of this loan is about a fifth of the interest I earnt last month on the other loans on TruePillars.

Having not gone through the process first hand, I thought it was a good time to go back over the process to understand the next steps.  From the loan dashboard the notes outline the borrower has petitioned for bankruptcy and as is now in a formal process we must wait for the bankruptcy trustee to provide an update.  For this particular loan, we were an unsecured creditor so we expect to incur a material write-off (i.e. expect to lose some or all of our investment outstanding).  From this point, it will sit on our list of loans until a final outcome is determined.  I’ll keep you posted on how that looks.

While this is the outcome of this loan, I see that TruePillars have several options available to them as described in the PDS (Product Disclosure Statement) to work with the borrower for the best outcome for all parties.  This may include extending the final maturity of the loan by up to three years (lower’s the monthly repayments of the borrower to improve business cash flow which will allow it to continue to operate).  If this does not seem like a viable option, TruePillars may agree to a partial payment in full and close the loan (with material losses) or assign it to a third party (again with material losses to investors).

This default has hammered home the point that diversifying your loan portfolio is extremely important to ensure you minimise your risk and enable you to remain profitable in the event of a loan default.  Although I have focused on the process of what happens from an investor point of view, I think it’s important to take a moment and acknowledge that this can’t be easy for the borrower.  In this particular case, it was a small business owner who has just lost their livelihood.  For me, it certainly puts it into perspective that all I lost was a small part of a larger income producing portfolio.

Understanding P2P interest rates and how they are set

With the Reserve Bank of Australia having recently cut the cash rate to a record low of 1%, I thought it prudent to delve into how Peer to Peer platforms set their interest rates and if the cash rate has an impact on the rates we can expect as an investor.  For this I will focus on three platforms, TruePillars, RateSetter and OurMoneyMarket and highlight the key points of the Product Disclosure Statements (PDS) around how interest rates are determined.

TruePillars

This platform focuses on loans to small and medium sized businesses with terms of up to 5 years.  Every application has an assessment completed to risk rank the application and assess if the business has the capacity to repay the potential loan.  This is done through a combination of quantitative and qualitative data supplied by both the borrower and third parties.  Some of the key data points that feed this rating include

• External credit agency data and score
• Industry sector & geographic region
• Nature, size and age of business
• Management team and track record
• Financial statements and bank account data
• Commercial invoice payment performance
• Court Judgements and bankruptcies (current and historical)
• Proprietors/director’s consumer credit information
• Key macro-economic indicators

Based on the outcome of this analysis a decision is made to either progress the loan or not.  If the loan is progressed to Auction, a risk ranking is applied from 1 to 5 (5 is the highest ranking / lowest risk borrower). 
Approved borrowers are listed on the reverse auction site with upper and lower limits on the interest rate to ensure investors are appropriately compensated for the risk borrower poses even if demand from investors for the loan is high. 

RateSetter

This platform provides both consumer and business loans.  RateSetter completes a credit risk assessment to determine the borrower’s creditworthiness.  This process is broken into three phases; Application Assessment, Risk Assurance Charges and Credit Assessment.
The Application Assessment is the first pass credit assessment based information provided by the applicant and third party credit reports.  An applicant may not progress past this step based on the outcome of their risk profile.
If an applicant does progress, a Risk Assurance Charge is determined based on the borrowers expected risk of default.  Note on this platform investors are not paid a premium when lending to risker borrowers (nor do you know if you are lending to a risker borrower).  Instead borrowers pay a risk assurance charge that goes into a provision fund that is used to compensate investors in the event of borrower defaults.  The higher the risk of the borrower the more they are required to pay into the provision fund.
The last phase is the credit assessment, which takes a more detailed review and confirmation of the applicant’s details.  This may include, but not limited to:

• Verification of the applicant’s identity
• Confirming employment status
• Verifying living expenses and other debt obligations
• Assessing applicant’s income is sufficient to meet living expenses, existing and new loan obligations without causing hardship 
• Confirming security for the loan (if applicable)

A similar process to the above is applied to business loans with a focus on the business financial health and ability to service the loan.
The final interest rate is set by investors and borrowers on RateSetter’s open market platform.  Market supply and demand influences the final rate investors and borrowers agree to. 

OurMoneyMarket

This platform provides consumer loans up to a 7 years in length.  Interest rates are determined by the Interest Rate Committee whose objective is to set competitive rates to borrowers whilst providing competitive risk-adjusted returns for investors.
The committee consider a number of factors including

• General economic environment
• Estimated default rates per loan grade
• Loan terms
• Competitive factors such as rates set by other marketplace lenders and banks

From there interest rate bands are assigned to the loan grades A+ to D with A+ loans determined as the highest rating (lowest risk) borrowers.
The credit history of individual borrowers determines the loan grade that is applied and based on their unique circumstances and credit history a personalised rate (with the band) will apply.  This fixed rate loan with the relevant details on risk is offered to investors for funding.

As you can see, platforms utilise different methods for setting interest rates based around a credit assessment of the borrower.  Although there is no direct reference to the RBA’s cash rate, there is reference to economic conditions which typically would include cash rate movements.  So while a rate cut does not automatically mean a reduction in returns to investors, there is the possibility that returns may reduce to match the new economic conditions. 

From my general observations, I have perceived reductions in returns on TruePillars and RateSetter although these happened prior to the RBA cuts and appear to be driven by demand from investors and not related to a drop in the cash rate.  In contrast OurMoneyMarket rates appear to have remained stable to date.  I believe this because the final interest rate paid by the borrower is not affected by the demand from investors as is fixed as part of the credit assessment.  Interested to hear other people’s thoughts and observations on interest rates and returns received from Peer to Peer platforms.

Pete2Peer Portfolio Performance

The last six months has seen the introduction of two addition P2P platforms into my investment portfolio.  With a growing portfolio of four peer to peer platforms I feel it’s time to give an update on how each has tracked and provide an overview of how the portfolio has performed as a whole.

TruePillars

In the last six months adjusted my focus on loan diversity and have been working to lower my individual exposure to a single loan: I’ve made great headway in this regard with just under 100 different loans and a current max exposure of 3.6%.  New loans I purchase into now only account for approximately 1.2 % of my TruePillars portfolio.  To date I’ve not had a single default although I am tracking a couple of loans that have experienced late payments. 

I’ve sliced data two ways to show the makeup of loan grades and the distribution of the industries I invest in.  TruePillars rates loans from 1 to 5 with 5 considered the lowest risk below is distribution of loan grades in my portfolio.

With 100 loans it allows for diversification across multiple industries.  Breaking these out based on the standard industries against each loan, the following pie chart shows my investment portfolio distribution.

Overall my TruePillars account is progressing well with some steady returns of just over 12%.

MoneySpot

This platform has been a consistent earner for us with no active involvement required from myself achieving annualised returns of around 12.6%.

RateSetter

I’ve continued to add to this platform most months which has resulted in the returns currently a little depressed compared to what I was expecting of them.  The returns are currently achieving around 6% which I expect should level out at around the 8% mark.  Over the next few months I expect to continue to add some funds to increase the overall portfolio weight of this platform.  

OurMoneyMarket

This platform is still relatively new for me and I’m still working to get funds invested with only 14 loans currently in the loan book.  The platform has required a lot more work on my part to diversify my funds across multiple loans – more than I expected and hence returns have been slow building up.  The reporting on this platform is also not user friendly to generate your own reports.  As such I’ve pulled the basic info from the site to show my current investment values in their respective loan grades.  OurMoneyMarket ranks loans from A+ to D grade loans with A+ considered lowest risk borrowers.  

While I’m still investing funds in this platform the returns have been low but I expect them to continue to grow.  It’s currently too early to project where I think my performance settle.  I’ll keep you posted and how it is tracking in about six months’ time for a relative comparison to the other platforms.  

Overall Performance

To keep track of the individual performances of each platform, I track them on a single graph below.  In addition to this I aggregate the results to give my overall portfolio returns.

We can see that the overall returns of the portfolio are tracking about 11.4%.  Part of the driver for this is the current overweight allocation to TruePillars and MoneySpot.  From the graph below we can see that two platforms currently make up 80% of my invested funds.  I’m working to change this over the next few months to see a more balanced portfolio moving forward.

Some might question why you wouldn’t just invest all your funds into the platform that provides the best returns, the need for diversification across platforms is important to ensure you are not exposed to the risks of a single platform.  These are my results achieved to date and everyone will be different based on the loans in the mix.  As always interested to hear other peoples’ experiences and returns.  

Do you have time to invest in Peer to Peer Lending?

I’ve have been asked recently by several followers how much time I actually spend managing my peer to peer investments and at first I didn’t really have an answer.  Having thought and reflected on this, it’s a valid question as you must place a value on your time.  Thinking through what I do, I’ve broken down my thoughts on how much time I dedicate to managing my Peer to Peer Lending accounts.  As I currently invest in four different platforms, I’ve split out my thoughts on each.

TruePillars – If you are a regular follower, you will know TruePillars was my first peer to peer investment platform.  As such I spent a lot of time on the site in the beginning learning about the platform and understanding how the process worked and buying up loans on the secondary market as well as new loans when available.  Now I spend much less time on the site.  I would check the account once a week or so to take note and track any loans that are overdue (5 minutes a week).  In addition to this when new loans are listed (which I’m notified by TruePillars via text) I’ll log on and place a bid on the new loan (5 minutes to log on have a quick read through the loan on offer and place a bid).  However I’ve just activated the auto bid function to reduce my time commitments now I’m comfortable with how the platform works and keen to test this functionality out.  In addition to the above at the end of the month spend about half an hour reviewing and updating my performance tracking.

MoneySpot – This platform takes no time on my part to manage.  The platform is based on pooled fund where you are paid a return on the funds you have invested.  Apart from the time to fill in the application form, it’s checking once a month to have a read of the monthly report and taking note of the returns I’ve received which would take less than 10 minutes.  In my case I’ve opted for auto reinvestment to allow my investment to grow at a compounded rate.

RateSetter – This platform also takes little time on my part to manage.  When I add funds in I log in a few times to split up the funds I’ve commit to loans to help me feel comfortable I’ve diversified across multiple loans.  Each time it might take a few minutes.  On top of this I’ll log in once a week and reinvest any repaid funds sitting in the account (5 minutes).  I’ve not used the auto invest on this platform as I believe I can get a slightly higher rate by manually entering noting there is a time commitment on my part.  On the flip side if you are time poor and prepared to accept the auto bid prices this could be used as a time saver.  Like the other platforms at the end of the month I’ll also spend about 10 minutes or so reviewing and updating my performance tracking.

OurMoneyMarket – This platform is still relatively new for me and is currently where I’m spending more time while I work out how to get the best out of the platform and get my funds invested across multiple loans.  This would typically look like logging in every day or two to check for new loans to invest in (5 mins a go).  Again at the end of the month to track my monthly performance.

Adding up the different times spent, overall it would equate to under 45 minutes a week and an extra half an hour at the end of the month while document my performance of the different platforms.  While this is my experience investing over multiple platforms, I realise not everyone is the same and may not have similar time available.  To be honest, you can be as active or passive as you like, as each platform I invest in, offers a form of auto investing to cater for the time poor.  I’m comfortable with the time I spend as I like to be more actively involved and want to understand what I am investing in.  As I become more familiar with the platforms, I’m more comfortable with using the auto invest functions where appropriate.  Interested to hear about other people’s lending experiences and times commitments they make.