As lenders prepare for a potential rise in defaults, Michael Lloyd explores the life cycle of bad debt, and how collections and recoveries can be managed in the post-Covid economy…
What happens to bad debts? That’s a question that has been thrust into the spotlight in recent months, as Funding Circle has sold off some of its defaulted loans to Azzurro Associates, a debt buyer owned by US asset manager Elliott Management.
The peer-to-peer lending platform sold 280 defaulted loans to Azzurro late last year and completed a fresh deal this June.
Yet when news emerged of the first of these bad debt sales last December, Funding Circle had to defend itself from criticism that the sale could hurt vulnerable borrowers during a time of particular economic hardship. The platform has explained that the loans represented a small fraction of its overall loanbook, and that all struggling borrowers are offered support including short-term payment plans.
MP Kevin Hollinrake, co-chairman of the All Party Parliamentary Group on Fair Business Banking, publicly sought assurances that Azzurro Associates will recover any outstanding debt from the business and business assets before attempting to recover from the personal assets of a guarantor.
“When selling off debts to a company that is not customer facing, we have concerns but we understand Funding Circle has the right to do this,” Hollinrake told Peer2Peer Finance News.
“The next step is to mitigate the risk. We spoke to Azzurro and received assurances from them and Funding Circle that the personal guarantees will be dealt with in the right way, realising business assets before personal assets.
Read more: A history of P2P’s bad debt sales
“I don’t think it’s right lenders can sell loanbooks to organisations; they have a duty of care to that lender and borrower and it’s natural to assume if borrowing from a well-known entity, that organisation is more likely to treat its borrowers fairly and we’ve seen instances where that is not the case when the debt is sold off.”
Hollinrake is now calling for the Lending Standards Board to update its Standards of Lending Practice to ensure that business assets are always recovered before personal assets.
“One of the things we want to be careful with in this space is personal guarantees being taken in the right way,” he adds. “Most people think to try and help them restructure, it’s business assets before personal. That’s not a requirement.
“We’ve been speaking to the Lending Standards Board and other lenders and speak regularly in parliament about UK-regulated financial services entities selling loanbooks off, particularly in these kinds of circumstances, and are keen to try and change the rules about how this can happen.”
Funding Circle declined to comment for this feature.
However, last month it emerged that the platform’s latest bad debt sale was set to return £16m to individual investors.
“Azzurro Associates is Financial Conduct Authority (FCA) regulated and as the first commercial debt firm to join the Lending Standards Board, we are confident they will continue to service these borrowers with the equivalent level of service and care,” Lisa Jacobs, Europe managing director of Funding Circle, said at the time.
Selling defaulted loans is one way to recover debt and it tends to be the final act of the lender, after all other recovery options have been explored.
But every debt sale begins the same way – with a late payment on a loan.
After a certain period of time, this late payment becomes a default, and the defaulted loan goes into recovery.
According to the FCA, a property-backed loan can be classed as being ‘in default’ when a payment is 180 days overdue. For loans which have not been secured on property, the deadline is 90 days after the original due date.
“I think 180 days for property backed lending is sensible because of the nature of the transaction,” says Stuart Law, chief executive of Assetz Capital. “It often has delays working through it and we can’t do things instantly.”
Collection and recovery processes differ from platform to platform and experiences vary on a case by case basis. But all P2P lenders point out that they work with borrowers to find out what the issue is and determine what they can afford, then agree to a revised payment plan or payment holiday.
“When people get into default their head gets fuzzy,” says David Bradley- Ward, chief executive of Ablrate.
“It’s a situation where you need to calm them down and say ‘we’ve defaulted and let’s work with you to see how we get out of it’ and that’s the general approach.
“A legal situation is expensive for everyone – us, the borrowers and lenders. Pulling the trigger immediately is never the best way to do it.
“The best way is to evaluate and work with the borrower but if they are completely belligerent, we get the insolvency practitioners and lawyers in and let them do what they do.”
Read more: P2P specialist debt recovery firm launches
P2P consumer lending platform Lendwise triages its overdue borrower cases. Where a borrower requires more help with their money management, the case can get sorted within a week. Others require forbearance of some kind, while others may require a bit more chasing via emails and letters.
“And then if we have no luck, we will consider other options including legal routes,” says Rishi Zaveri, chief executive of Lendwise.
For LandlordInvest, depending on the specific situation, failure to repay a loan without any reasonable explanation will lead to a demand issued by its solicitors. This is followed by a final demand and thereafter receivers or administrators are appointed.
ArchOver remains in close contact with troubled borrowers so it is aware if an interest payment might be late or if there might be reporting issues. The P2P business lending platform will immediately serve a breach warning notice called an RN01 if the payment does not arrive on the due date.
“The RN01 points out the breach issues against the 36H facility agreement,” says Ian Anderson, chief operating officer of ArchOver.
“If we believe the firm is in serious trouble we will give as little as 24 hours to rectify it before declaring a default.
“Our normal period is seven or 14 days. The RN01 is really effective at giving borrowers a jolt to sort out their money or reporting.”
Alex Hilton-Baird, managing director of debt collection agency the Hilton-Baird Group, says prevention is better than the cure and the best way to collect customers’ debts is by being firm and fair.
“I don’t think I’d ever use the word aggressive in anything we do,” he says.
“It’s nothing to do with being hard or aggressive as some people put it, it’s about listening to the reason for non-payment somebody is telling you and working with that customer to find a solution.
“The best way to collect money is by building a relationship with those owing the money and understanding why they’re struggling to make repayments. The majority of people would pay on time if they could.”
Hilton-Baird says what happens next depends on the guidelines agreed by each platform, but the threat of legal action can make all the difference.
“As a rule of thumb, it would typically be where the customer is not engaging at all with you and you have done enough research to know the customer does have assets, very often the act of issuing court proceedings tips the balance,” he says.
“Unfortunately, there’s human nature in this. Many bury their heads in the sand and have other priorities, a letter from the platform hasn’t resonated and, although a letter from us may have got them to pay attention, the next legal escalation point is notice of issuing legal proceedings.
“By far, most recoveries are pre-legal notices and working with customers and talking to them.”
As well as communicating with borrowers to recover repayments, platforms also need to be wary of vulnerable customers and have collections experts who can listen and pick up on signs and take appropriate action.
Hilton-Baird says he believes the sector’s collections processes have withstood Covid and while the underlying principles are largely the same, P2P platforms have more-data driven systems that are easier to interface with.
“The big difference in terms of being a debt collection agency working for both sectors is the flow of information,” he says.
“Most P2P lenders are very data driven. Therefore, the systems they have are easier to interface using API connections, so the data exchange and reporting is better.”
Debt management and collections will become more significant for the P2P sector as the first batch of government-backed support loans come due. Defaults are expected, but the real test will be how P2P platforms respond to them.
John Cronin, an analyst at Goodbody, has forecasted more bad debt sales along the lines of Funding Circle’s sale to Azzurro Associates.
“Clearly there’s a strong recovery underway in the economy and that should be supportive in both a collections and recoveries context,” he says.
“I think given the environment we could see other P2P lenders going down the route of selling bad debts. Certainly, Funding Circle may stimulate others to think about it.”
How P2P platforms respond to additional defaults will shape the future and this can only be aided by a swift economic recovery.