Provision funds are still alive and well in P2P
THE UK’S oldest peer-to-peer lender is getting set to withdraw its provision fund but there are still platforms that investors can choose if they feel more comfortable with a safety net in place.
Zopa has announced it will wind down its Safeguard fund from December, which will result in higher returns.
The move means that the so-called grandfather of P2P will no longer have a provision fund, like other major platforms such as Funding Circle.
But there are still well-known P2P brands offering an underlying provision or insurance for loans.
RateSetter was the inventor of the provision fund concept, offering it at launch in 2010, pre-dating Zopa’s safety net by three years.
RateSetter’s provision fund, built up by borrower fees, covers bad loans, and following a restructuring earlier this year it now displays a capital coverage ratio along with the amount held inside the fund, showing its ability to cover losses based on expected levels of defaults and future income.
Its current capital coverage ratio is 279 per cent, meaning actual future losses would need to be 2.79 times larger than expected future losses before investors’ initial investment starts to be at risk.
Wellesley offers a provision fund similar to RateSetter and Zopa but has paused its P2P business and is currently reworking its offering so it is unknown if this will be offered once it relaunches.
Personal loans P2P platform Lending Works offers an insurance and reserve fund scheme called The Shield.
Topped up by borrower fees, The Shield insures borrowers against missed payments due to accidents and sickness as well as defaults due to loss of employment or death.
The Shield currently has enough to cover 2.7 per cent of bad debts, above the actual historical bad debt rate of 1.2 per cent, but just below its expected default rate of 2.9 per cent.
Property lender Landbay runs a reserve fund on a discretionary basis.
This means there is no guarantee an investor will be repaid from bad debts, but they will also have a security charge over the property.
It is funded using a proportion of the borrower platform and product fees.
If a borrower defaults on their mortgage and there is a shortfall after selling the property, less all related enforcement costs, a claim will be made on the reserve fund for any remaining principal and interest due.
The size of the fund is currently 0.6 per cent of its loanbook, with estimates of defaults making up just 0.1 per cent of its business.
Lendy’s provision fund aims to maintain a balance of two per cent of the loanbook, funded by borrower fees.
The fund is in place to assist in compensating investors in the event that the sale of the security property does not result in full repayment of the loan.
The fund is held on a discretionary basis and Lendy says it cannot guarantee that any claim will be approved.
Business lender Growth Street’s loan loss provision is funded by its founders as well as a portion of borrower repayments.
It is designed to repay lenders in the event of a borrower default by making payments on behalf of the borrower when they become due or, in cases where we think there is no reasonable chance of recovery.
If the fund were depleted below the level of expected losses, Growth Street would declare a “resolution event”. All outstanding loan contracts would be automatically assigned to the provision fund.
Repayments would then be shared out pro rata to investors to ensure diversification of default risk. There would be a material delay in repayments being made.
Its fund currently has enough cash for 7.4 per cent of outstanding loans, compared with expected defaults ranging between three and four per cent depending on the sector.
The business and property P2P lender offers separate provision funds on its Green Energy Investment Account, Great British Business Account and Quick Access Account.
The funds aim to cover payment delays, shortfalls in interest received from a borrower and any loan defaults.
All three currently have enough coverage for four times the loans in these products.
Supporters of these funds claim they give investors more confidence as they know a safety net is in place to cover missed payments or defaults, but critics claim it lowers returns and there is no guarantee that there would be enough coverage.
The Financial Conduct Authority has also expressed concerns that having a provision fund may make investors think a platform is less risky.
A provision fund is no guarantee of safety and all platforms will argue their risk assessments and due diligence are as important.
So investors need to consider the benefits and drawbacks of a provision fund alongside the other risks and rewards of P2P lending.