Funding Circle is an impressive story, one of exceptional growth and global expansion, while still supporting the ‘backbone of the economy’; small to medium sized businesses. It is a story of a venture capitalist backed start-up that has delivered on its growth promises and as the story continues we eagerly await its latest milestone, the Funding Circle IPO.
There is no hard-set date for the offering, however as described on Interactive Investor ‘the offer period for the Funding Circle IPO is expected to open in the coming weeks and may be short’.
The minimum application size in the retail intermediaries offer will be £1,000 and it is expected that shares will be open for trading in October. Participating intermediators are listed below:
- AJ Bell Youinvest
- Albert E Sharp
- Barclays Smar Investor
- Cornhill Capital Limited
- Saga Share Direct
- Hargreaves Lansdown
- com Limited
- IG Group
- Sharedeal Active
- Redmayne-Bentley Stockbrokers
- SVS Securities Plc
- The Share Centre
- WH Ireland Limited
What has excited us is the documentation that has been released by Funding Circle. Until recently the public have had access to the loan book and financial data through Companies House only. Within the IPO registration document, Funding Circle’s business is described in detail, some of which is relevant to investors on their platform. Below we’ve included a couple of highlights from the document.
How much P2P platforms earn on each loan has long been difficult to estimate. Funding Circle has two revenue streams in its business, an annual loan servicing fee charged to its investors of 1% and an upfront fee charged to borrowers, immediately after the fee is fully funded on the marketplace. These are described by the following performance metrics.
- Transaction yield. This represents the total revenue the Group derives from Borrowers for originating loans on the platform, divided by the value of the loans originated.
- Servicing yield. This represents the total revenue the Group derives from servicing loans outstanding on its platform, divided by the average value of Loans under Management in that particular period.
The table below shows the transactional yield earned by Funding Circle has increased from 3.6% in 2015 to 4.8% in 2018. Combined with an increase in origination, Funding Circle’s revenue has grown from £32m to £63 million in this period.
Table 1: Funding Circle revenue
The transactional yield represents the additional fees over and above the lender rate, which can be used as an indication of credit risk. It’s worth noting that this is an upfront fee charged on loans that average 52 months in term so on an annual basis the overall revenue (transactional + servicing) per loan is 2.1% in 2018.
The diversity of Funding Circle’s investor base has also increased over time as shown graphically below. It can be seen that only 31% of the investor base is now occupied by retail investors.
Figure 1: Funding Circle investor base
A fairness of lending is delivered across this investor base by three principles. This essentially ensures that institutions and segments of the retail investor base are not cherry-picking loans over passive retail investors.
- Passive investment: all UK institutional and retail Investors invest passively through Funding Circle’s platform.
- Random allocation: Funding Circle operates a whole loan market for institutional investors and a partial loan market of retail investors. Loans are allocated between specific Investors on a random basis
- Diversification: Funding Circle always seeks to ensure adequate diversification of loan portfolios.
The above lending principles have delivered returns ranging from 4.4% to 7.2% as shown below.
Figure 2: Funding Circle projected returns
Funding Circle further stress tests its loan book to estimate the impact of an adverse economic climate. Following the same stress test guidance as the top banks, as provided by the Bank of England, the potential impact of a hypothetical adverse scenario on Funding Circle returns can be seen in the chart below.
Figure 3: Funding Circle stress test result
In a stressed environment, Funding Circle estimated that the default rate for small businesses would increase by 1.9x, compressing investor returns to 2.4% -4.3%.
Another interesting view is a comparison of returns across the different geographies which Funding Circle operates, namely, UK, US, Netherlands and Germany.
Figure 4: Funding Circle return across geographies
Although the returns and defaults do vary, there are distinct similarities, demonstrating a consistency of lending across the markets.
The majority of loans are funded by existing investors with new investors funding 15% of origination over the last two years.
Figure 5: Origination funded by new vs. existing investors
The Funding Circle Innovative Finance ISA (IFISA) was launched in March 2018 and now 6% of retail investor capital is funded from ISAs.
Figure 6: ISA account performance
The average account balance of an ISA as shown in the chart above is, however, higher – closer to £18k – than general investment accounts of £9k.
There is significant room for Funding Circle to grow with a large addressable market in each of its chosen markets. In the UK, marketplace lending platforms account for 1.1% of the market while the main banks of Santander, Barclays, HSBC, Lloyds, Nationwide and RBS still dominate the SME debt financing market with a 65% share.
Figure 7: SME debt financing market share
Within the SME lending platform market, however, Funding Circle is a market leader in all its geographies.
Figure 8: Relative market shares of SME lending platforms across markets
Funding Circle is an inspiring story and the company, as described in their IPO documentation, has much room for growth. It’s a positive story for the peer to peer lending sector and FinTech more generally. Now… it will be interesting to see how this story is reflected in the share price.