Using your assets
Secured and unsecured loans are plentiful within the P2P sector. Peer-to-Peer Finance News investigates the benefits of both
Deep down, even the most risk-aware investors want some level of security. While they may be able to tolerate some losses, they aren’t going to put their hard-earned money in a company which has no back-up plan should their investment go AWOL.
This is why security is so important in P2P lending. As the sector grows and regulation increases, investors are becoming more and more discerning when it comes to the quality of loans. And the platforms are listening. There are a number of P2P lenders who only deal in secured loans, while even the unsecured loan books tend to be protected by personal guarantees and platform-funded provisional funds.
However, there is a world of difference between the different forms of P2P security and it is a subject which tends to provoke strong opinions across the industry.
“We invented secured loans,” claims Kevin Caley, chief executive and founder of ThinCats. “Back in November 2009 we had the first idea for doing this. We came at it from the point of view of having a really low-risk investment opportunity and knowing that banks weren’t offering it. We started off assuming that everyone would want security – it didn’t occur to us to not ask for it – so we were surprised when other people came along offering unsecured loans.”
However, not everyone has the same perspective as Caley. Among the three largest platforms, RateSetter and Funding Circle offer both unsecured and secured loans, while Zopa’s loans are all unsecured. So far, industry default rates do not show a discernible contrast between secured and unsecured lenders.
“Just being a secured lender isn’t the be all and end all,” says Andrew Holgate, chief credit officer at Assetz Capital. “Certain assets fluctuate in value. Things like agricultural land – its only ever going to be another farmer that wants it. It’s understanding everything that goes into the value of an asset that makes you a good secured lender.”
Most P2P lenders agree that there is a general hierarchy of quality when it comes to loan security. At the top of the pile is property and other tangible assets such as machinery, land and vehicles, although as Holgate says, any of these assets could fluctuate in value over time.
“Lenders like property,” says Guy Weaver, a director in KPMG’s debt advisory team. “But it comes down to the type of property – where its located, the strength of the property and the type of property.
“It can be an owned property, a business over a property or a commercial property which is lent to a third party, so the strength could be the bricks and mortar but also the lease contract. You have to ask – what would it be worth in a worst-case scenario?”
After property, there are the less tangible assets such as debentures, bank accounts and the company’s own balance sheets, although again, you won’t know what these are going to be worth until the business fails. Most debtors will try to do a deal by offering investors 80p on the pound, or less. This may represent the best value for an investor when the alternative is a protracted legal battle which may not work out in their favour.
Finally, there are personal guarantees. These are legally-binding documents which list any assets of the borrower which could be used to repay the loan if they should default. However, they are controversial.
“You don’t have anything tangible to use that on apart from some due diligence that you’ve done that says whether that person is reliable,” says Holgate. “You’re basically going on that assumption that they’ll pay – it’s a very dangerous assumption.
“We do take personal guarantees but they’re normally the conduit for then taking a secondary charge on other assets. We want the director to feel a little bit of pain – if something goes wrong that there’re on the hook.”
Personal guarantees may work for some lenders, but when they don’t, they can leave a lot of damage in their wake. When ThinCats dabbled in unsecured loans, they ended up with hundreds of thousands of pounds in debt, some of which they are still chasing to this day. In both of those cases the borrowers signed personal guarantees and in both cases ThinCats was unable to recover the money.
“In our second year we got caught out quite early on and that’s where we made the most losses,” admits Caley. “The first failure we ever had was a conference management company and we relied on personal guarantees and the value of the debtor book. We lost £100,000-150,000 on that one.”
In the second instance, the company took a personal guarantee from the chairman of a cleantech company, however “the company ran out of money and the chairman managed to shift his assets into other areas so we had no assets to go after,” says Caley. “We probably lost around £200,000 on that.
“By that way that still shows up on our records so we learnt a hard lesson.”
It would be easy to take these examples as proof that unsecured lending is to be avoided at all costs. So why do the three biggest platforms continue to use them?
“The attraction of unsecured loans is the flexibility,” says Weaver. “They’re going to be cheaper to put in place because there are additional legal costs about putting in place security.”
Weaver says that when it comes to unsecured lending, the speed that they can move at is “phenomenal”. “Within minutes of someone applying for borrowing, they can actually secure that loan,” he says.
This speed is one of the major selling points of retail-focused P2P platforms, who rely on a high turnover of borrowers to match their growing community of lenders. By avoiding a complex security approval process, they can also cut down on admin fees and pass on the savings to their clients, who are generally using P2P loans as a way to either save money (on borrowing) or make money (on investments).
In such a dynamic sector, there certainly seems to be room for both secured and unsecured lending. And while most lenders tend to come down on one side or the other, they are happy for different types of security to exist, as long as the investors understand the various risks.
“Within the business space, there is a place for unsecured loans,” says Holgate. “However, I think certain markets – such as the real estate market for bridging loans – should be secured.”
The diversity of P2P platforms, borrowers and investors makes this mix of unsecured and secured loans an essential component of the sector.
“Security is very complicated,” says Caley. “You need a lot of expertise and experience to be able to judge it properly.
“The people doing smaller loans, there’s no point in them taking security because the cost of taking it and enforcing it is disproportionately high. It isn’t really worth it until you are taking loans worth £250,000 or more.”
In the end, it’s a numbers game. For some lenders, the ability to approve loans cheaply and quickly far outweighs the risk of losing assets, particularly when those losses have already been built into their projected returns. For others, unsecured loans are simply a risk too far. As long as the platforms are doing everything in their power to protect and inform the investor, every form of security has a place in P2P.
Can a personal guarantee ever truly be enforced?
Personal guarantees are an extremely popular form of security for smaller loans and are widely used throughout the P2P sector. But they are not without their critics.
Some people have suggested that they are little more than a gentleman’s agreement – a mere promise to pay back any loan by using their existing assets. The risk is that an unscrupulous borrower will sign a guarantee, then sign those assets away to a spouse or business partner the following day, making asset recovery next to impossible.
“When things start to go wrong, it’s natural for people to look for ways to protect themselves,” says Andrew Holgate of Assetz Capital. “Will they hide assets? Will they move money in to their wife’s name? Yes, they will.
“You need to be able to prove that they had ownership of that asset at the point at which they went into the loan. You might have to get forensic accountants involved and at that point you’re into lengthy court processes.”
And as ThinCats’ Kevin Caley says, “there’s a whole industry of lawyers there to advise people on how to get out of their personal guarantees.”
However, the law is wise to these scams and there are some measures in place to protect lenders against personal guarantee fraud. There have been a number of high-profile insolvencies where the court has ruled that the debtor has to pay the investor, regardless of whether or not they are still attached to the assets in the original document.
However, as Holgate pointed out, these battles can be costly and lengthy, so may not be worth the hassle in the long run. Perhaps this explains why personal guarantees are not used against multi-million-pound loans – some battles you just can’t afford to lose.