By Gareth Vaughan
New Zealand's second operational peer-to-peer (P2P) lender Squirrel Money isn't roaring out of the gate like rival Harmoney did because it's not using funding from banks or institutional investors.
Managing director John Bolton told interest.co.nz in a Double Shot interview the pace of Squirrel Money's growth will be dictated by those who invest in loans through the firm's website.
"One of the key things for us is that we have intentionally not put a bank or investment bankers behind the platform so that all of the funds that are raised have to come from retail investors," Bolton says.
"That means that you've got to be a bit careful and you're going to be a lot slower in how you lend out. The way I view it is it's going to be a bit of a growth curve. It's going to be slow to start with, probably for the first six to nine months, but we'll see it steadily increase as investors get more comfortable with the way that we're doing things."
"Our growth rate's going to be very much dictated by the investors. The more money that's invested through the platform, the more we can increase the amount that's lent out to borrowers," adds Bolton.
In August, after Squirrel received its licence from the Financial Markets Authority, Bolton told interest.co.nz he'd be "more than happy" if about $50 million of lending is facilitated over the firm's first two years.
That contrasts with Harmoney, which with the help of funding from shareholder Heartland Bank and institutional investors, lent more than $100 million in its first year. Harmoney has also secured $200 million of institutional funding from the British based P2P Global Investments PLC as it pushes into the Australian market. And in the more mature US market, P2P lenders are bundling and selling off loans through securitisations.
Squirrel launched at the start of November. Speaking last week, Bolton said it was poised to pass $600,000 of loans facilitated, with an average size of about $20,000 and the majority borrowed for five years. Although it offers both secured and unsecured lending, Bolton says unsecured loans are dominant thus far.
Much of the lending arranged early on has been A and B risk grades, with hardly anything below C grade.
"Our intention's to keep it that way. We really want to stay in that bank quality end of the market," says Bolton.
'No shortage of borrowers'
Squirrel, he says, is rejecting between 70% and 80% of loan applications. In terms of the loans it is facilitating, most are for car purchases, debt consolidation and general "tidying stuff up for people."
"There's no shortage of borrowers out there. What we've learned very early on is that we can dial that up or down at will. But obviously what we want to do is not have too many borrowers on the platform because there's nothing worse than sitting there and not having a loan funded for an extended period of time," says Bolton.
He describes initial investors as "early adopters" who are investing small amounts of money to see how it goes.
"Their first interest payments are going to start to come out in the next week or two. Then gradually from there I think you'll start to see a bit more confidence and they'll see how it's working and how it's flowing."
Bolton says there's a bit of a mis-match between borrowers and investors early on with the vast majority of borrowers wanting five year terms and investors typically wanting two to three years.
"What we've been educating investors on is that these investments repay like a loan. So you've actually got principal coming back from day one, and 32% of the principal on these loans is actually getting repaid in the first two years," says Bolton.
"So although it's a five year investment horizon the reality is at the end of five years all of your capital has been repaid."
'As far as rates are concerned, the (investors') interest rate at five years at the moment is hovering around 8.5%. with those shorter terms we think they'll settle down around 7.5% maybe 8%, after money is being passed up to the investor fund to protect investors from credit losses," Bolton says.
Borrowers are paying between 10.5% and 13.5%. Borrowers' interest rates are determined by a contestable, auction type bidding process meaning the more investors that join in an auction, the lower the rates on offer are.
"We're not really getting it below 10.5% at the moment because there's not enough investors in the platform yet for competition to start to lower those funding rates," Bolton says.
Investors don't have to assess the risk of 'a whole heap' of loans
Rather than the Harmoney style fractionalisation that sees investors spread risk by spreading their money around numerous borrowers in small sums, Squirrel has a reserve fund, Loan Shield. This, Bolton says, works the same way as how a bank manages its credit risk.
He maintains an advantage of the reserve fund approach over fractionalisation is that investors don't need to spend time looking at "a whole heap of loans" assessing the risk of each loan.
"Our approach... is to pass the credit risk up to a mechanism that essentially diversifies it across the entire portfolio, which is what the reserve fund does, and therefore pass the benefit of that diversification straight through to the investors in totality."
"Roughly about 2.5% absolute, which is about quarter of the actual interest payment by the borrower, is passed up to the reserve fund. So the reserve fund will grow over time," says Bolton. "If a borrower misses a payment the reserve fund pays it straight away through to the investor so that the investor gets their regular return."
"We're reserving at 4% of the total lending outstanding. Our expected credit losses run between 1.2% and 1.5%. So we're reserving at over two times what we expect in terms of credit losses."
In terms of fees, Squirrel's key fees see borrowers charged a flat $250 fee for an unsecured loan, and a $500 fee for a secured loan. Investors pay a platform margin of 2%.
The Commerce Commission is looking at how P2P lenders are covered by the fees provisions in the Credit Contracts and Consumer Finance Act (CCCFA). Harmoney recently dumped its platform fee for borrowers that ranged from between 2% and 6% of the loan amount, based on the loan's risk grade, and introduced a flat fee of $375. The third licensed and operational P2P lender, LendMe, is however sticking with fees for borrowers of between 1% and 7% of the sum borrowed, depending on a loan's risk grade.
(Meanwhile, a Diana Clement NZ Herald weekend article suggested some investors are unhappy with Harmoney "churning loans to double dip its commission." Clement quoted Garth Stanish, director of markets oversight at the Financial Markets Authority, saying, "We were not aware of this alleged business model where investors' loan documents are cancelled and then rewritten when borrowers borrow additional amounts through the platform.")
'A proposition that stacks up'
Bolton is confident the Commerce Commission won't have an issue with Squirrel's fees.
"We always took the approach that whatever we did would be compliant with CCCFA," he says. "But for us it was actually about making sure we had a proposition that stacked up in terms of where we felt peer-to-peer sat in the spectrum."
"At the end of the day you have to be delivering a better proposition into investors and borrowers than they can get elsewhere in the market (from other P2P lenders, banks, finance companies etc). So for us a low upfront fee for borrowers and really competitive interest rates was really a starting point for the entire platform."
Bolton, an ex-general manager at ANZ, is also managing director of mortgage broker Squirrel Mortgages. This far he says there's little cross over between Squirrel Mortgages' and Squirrel Money's customers.
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15 Comments
Hi SS
If a borrower misses a payment it is covered by the Reserve Fund so the investor gets paid. The risk for the investor is that the reserve fund runs out of funding and can therefore not meet a missed payment. We have adopted a fairly conservative stance on this. We are reserving at 4.00% for the first year against expected credit losses around 1.20%-1.50%.
If the Reserve Fund looks like it is running down over time (loss rate greater than reserving rate) then the first thing we'll do is up the reserving rate on new loans.
Even after doing that if the Reserves were exhausted, or looked like they'd get exhausted, then we can divert part or all of investor interest payments (not capital) into the Reserve Fund to cover losses. This way ultimately any loss is socialised across the platform and is very much a worst case scenario.
In that regard security doesn't matter to the investor as it doesn't change their financial outcomes.
From a platform perspective we expect lower default rates where we have security and a lower loss rate given default so it influences platform risk. (We will report to investors what percentage of our platform is secured and what proportion is insured as these both have relevance to the Reserve Fund and our ability to manage and contain any losses.)
The loanshield concept is only for a fraction of the total loan book. If we had an economic downturn and say 20% of the loan book defaulted, the loanshield would probably only have enough funds to make good on a fraction of those defaults.. hence why having security to fall back on makes a big difference
Totally agree leverageup. They are relying primarily on the basis that they keep lending at similar levels, with no deterioration in the economic outlook. In my view they are playing a dangerous game over the first year or two, that is unless they have some equity. This is comparable to the life insurance game, which many insurers would agree is nothing more than a massive Ponzi scheme.
Hasn’t impacted us at all that we can determine. I think I’ve seen 2 other loans with respect to Harmoney in the past 12 months. The first we declined for a vehicle purchase - secured loan. The second was a couple of days ago and the counterparty was up to their eyeballs. So this is a very small sample. However if this is representative of the clientele I would be concerned. What I think is more interesting is that it appears as though the banks are coming down into this space. I suspect P2P is more of a threat to them. As a result in the past we typically saw utility, and finance coy defaults on credit files. Now we are seeing utility and bank defaults. Finance companies will invariably have loans secured by way of motor vehicle, and the loan repayments are in line with the depreciable asset. Banks seem to write mostly unsecured personal loans, and they tend to be over much longer periods. In other words the risk matrix has flipped on its head
Kane - I might be wrong but the challenge you guys had during the GFC was mis-match of your liquidity profile. Your investors were shorter than your loan book and you were running out of cash hence the need to go into moratorium.
We are very different to finance companies.
First the investor funds are put directly into loans and are held in Trust for the benefit of the investor. There is no call over these assets/loans as they are not ours.
We have very limited flexibility on what the money can be used for.
Importantly, we have no maturity mis-match. The loan and the investment term by definition are perfectly matched.
I've covered the credit risk aspect in previous comment above.
Depends on who you lend to and how big any market correction is. I love throw away comments like 20% that lack any analytical rigour.
The biggest correction in modern history in NZ was post 1987 (which got to its worst around 1992) and we briefly had an unemployment rate of 10.7%. Off the back of the Asian crisis in 1997 we briefly hit 7.70% unemployment and then 2012 at 6.90% post GFC.
The unemployment rate tends to hit lower skill occupations more and one industry towns. During the GFC companies were reluctant to retrench higher skilled roles as they knew they'd be hard to replace after the correction.
So ... if we (Squirrel Money) are predominantly lending to B-grade borrowers (who have a statistical probability of default of around 1.50%), live in metro areas, have an average income of $87,000 (mostly PAYE), clean credit records and 46% own their own house - how will we get to defaults of 20%?
We are happy to grow slowly and methodically, and are firmly playing in the bank space, not the traditional finance company space. We have no desire to chase high risk loans.
When harmoney first started I noticed it was really easy to get good loans, ie loan less than $3000, where the loan grade was A, B, or C, and the borrower was a non house mortgage holder. Now those loans seem few and far between with similar parameters finding mostly D/E-grade stuff. I wondered to myself where did all the good loans go? Is there just more competition among investors like me, or did they change the rating method, or are the good loans being fished out by institutional investors, or is it just in my imagination that the good loans have diminished a little?
sadr - you need to check your numbers.
the Squirrel money fee is only $250 for a loan up to $30,000. The AA is $256 including the PPSR fee.
The AA's lowest rate is 10.95% and Squirrel money's lowest rate is 9.00%-10.00%.
The Squirrel rates are driven by a market mechanism so change depending on supply and demand. Over time the rates will trend down as more investors come into the platform.
Ultimately P2P is going to deliver much better personal loan propositions than banks and finance companies because they take far less of a cut in the middle and are able to pass that benefit on to borrowers as lower rates and investors as better returns.
From my clients, a lot of the loan grade As have switched to two or more 0% credit cards as working capital. They have been at if for a couple of years now, easy to have 20-30k, over 12months partly paid down then switched again to another banks interest free credit card deal.
Hi SS
The provisioning rate is loan dependent. Higher risk loans carry a higher probability of default and loss given default and therefore attract a higher risk premium.
The expected credit loss on the risk grades we are writing is around 1.20%-1.50%. This is based on NZ loan default history. We scale this by 160% to factor in a downturn in the NZ economy and this is what gets charged to the borrower. In the first year we are maintaining the provision at 4.00%.
Cheers, JB
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