Similar to the analysis we conducted on the Zopa loan book, we have reviewed RateSetter’s loan book to provide investors with a better understanding of RateSetter’s investment offering.
RateSetter offers three investment products, or ‘markets’: a monthly Rolling Market, a fixed 1 Year Market and a 5 Year Market.
Investors are required to open an account, deposit funds and choose a market. Funds are then invested in varying loan terms, dependent on the market selected; 1 year loans, on the 1 Year Market; 4-5 year loans, on the 5 Year Market; and 6 month- 5 year loans on the Rolling Market.
Payment terms (which can be changed once your account is opened) and early access fees vary between the three markets.
NB: Statistics are correct at time of publication – 06/10/16
Within the three available markets, interest rates are set by the amount of available investors’ capital (market supply) and the amount of demand from borrowers (market demand). The advertised rates are the market rate, where market supply meets market demand.
Orca is the only third party service collecting P2P rates on a real-time basis. The below table shows RateSetter’s yearly average market rate. Please note the RateSetter 3 year income market is now closed to new investors.
Investors are exposed to the same level of risk irrespective of the loan market they choose. In the event of default, the RateSetter provision fund covers losses across all markets until the provision fund is fully depleted. If the provision fund runs out of funds to cover losses, RateSetter will activate a ‘Resolution Event’ where all outstanding loan contracts are pulled together into a central pot and investors are paid back on a pro-rata basis. Ultimately, this means investors are exposed to every outstanding loan on the loan book and not to their specific P2P loan contracts.
This is different to both Funding Circle and Zopa, where investors are exposed directly to their P2P loan contracts.
Early Access to Funds
Providing there are new investors on the RateSetter markets, current investors in RateSetter can withdraw their funds before the end of their term. As the RateSetter markets have become bigger, with more lenders, the average wait time for withdrawing funds has reduced to only 10 minutes. Once your funds have been converted from P2P contracts into cash, you are able to transfer this cash from your RateSetter account to your bank account.
When investing in the 5 Year or 1 Year markets there will be a charge for accessing your money early. RateSetter reports this to be an average of 0.72%, however, the actual fee depends on your individual investing circumstances. The rate you earn will be reduced to reflect the time you invested for: If you invested for 5 years, but withdrew after 1 year, the RateSetter system would reduce your interest rate down to the equivalent 1 Year rate. If the interest rates have risen from the time you originally invested to the time you withdraw your money, you will be charged a further fee to cover this difference. This means that the new investor who substitutes your loan commitment is not penalised.
The RateSetter Provision Fund
The RateSetter provision fund is central to the RateSetter offering. Borrowers pay a risk weighted contribution to the provision fund to cover investor losses. The provision fund currently totals £16.4m with a further £6.0m worth of future borrower contributions contractually obliged. RateSetter aims to hold 125%- 150% the value of expected defaults in the provision fund. This is known as the coverage ratio, which currently stands at 128%.
The ability of the provision fund to pay out is affected by the amount of money in the fund relative to the level of bad debt.
The above chart shows the provision fund is fully depleted when the bad debt rate rises to 3.9%. However, if defaults were to rise, RateSetter has the ability to increase the provision fund size by pricing new loans accordingly.
In drastic conditions where the provision fund is fully depleted and RateSetter is not able to increase the provision fund size, a ‘resolution event’ will be triggered. The trigger for this is not formally documented, however, in this event, all outstanding loan contracts are pulled together and investors are repaid on a pro-rata basis. If this was to occur, interest payments would be impacted and if default rates rose above 11.58% then investors’ capital would be impacted.
To-date, investors have never lost a penny through investing in RateSetter and the provision fund has covered all defaults.
The secondary result of the provision fund is that the actual return an investor receives is equal to the market rate. Below we’ve charted the investor returns across the entire loan book, alongside the weighted average borrower rates on a yearly basis. The differential between the borrower rate and the investor returns provides an indication of how much additional fees borrowers are paying to contribute to the provision fund. This is not the overall interest rate paid by the borrower which includes RateSetter fees.
Generally, investors are earning returns of 4-5% while borrowers are paying rates of 6-7%.
Liquidity – Amount Lent
The chart below demonstrates RateSetter’s growth over the past five years, allowing RateSetter to establish a 22% market share in the UK P2P market.
Cumulatively, RateSetter has facilitated over £1.4bn worth of loans since incorporating in 2010. Although institutional investors have started investing through RateSetter, the amount relative to retail investors is low. In 2015, 2.13% of RateSetter’s loan book was funded by institutional investors, compared with Zopa at 49.57%; RateSetter’s ratio is comparatively low.
The presence of institutional capital has positive and negative implications. It may be reassuring that professional investors are investing through P2P platforms, however an increase in large sources of capital places strain on borrower origination. This may lead to an imbalance of borrowers and lenders on P2P platforms, resulting in investors’ funds sitting idle waiting to be lent.
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Geographical Locations of Borrowers
If we plot total lending relative the geographical location, it would appear that RateSetter is predominately focused on lending to English borrowers.
However, the chart below demonstrates that on a per-capita basis RateSetter borrowers are located throughout the UK nations.
Default Rates – Performance
RateSetter’s default rate has been increasing over the past three years. The current actual default rate for 2015 – 2.29% – is likely to rise above the expected default rate of 2.75% given that 42.74% of the loans are still outstanding. This should not be perceived as a significant risk to lenders, as RateSetter has sufficient coverage in its provision fund and has the ability manage the amount held in the provision fund by re-pricing new loans.
Originally, RateSetter facilitated consumer loans only, however, the platform has extended its lending to businesses, property developers and loans to third party lending businesses. It can be seen from the table below that consumer loans are the reason for the high default rate in 2015.
Digging deeper into the consumer loans we can see that uncategorised loans are most likely to default with a rate of 4.59% in 2015. Paying of other credit – 4.24% – also has a significant default rate.
The mix of borrower types separates RateSetter from other P2P platforms and creates an extra layer of complexity in the RateSetter business model. A decision on whether to lend to an individual wishing to purchase a car requires a different skillset to a decision on a multi- million pound property development loan.
The categories within RateSetter’s loan book can be seen below.
RateSetter Consumer Lending
RateSetter first started lending to consumers and this borrower category currently constitutes the majority of RateSetter’s total lending at 59%. Within this group, the largest single category is car purchases at 25%, followed by debt consolidation at 21%. Business loans under £25,000 are lent to individuals and categorised as a consumer loan, accounting for 9% of all consumer loans.
RateSetter Wholesale Lending
Wholesale lending which accounts for 16% of RateSetter’s total loan book relates to RateSetter lending money to other lending businesses. This presents a potential risk as RateSetter is passing on credit decisions to third parties. Current, actual default rates in 2015 stand at 0.02%, suggesting that RateSetter is mitigating this risk sufficiently.
RateSetter Property Lending
RateSetter funds property developments that meet the following criteria:
- Loans of between £500,000 – £3.5 million
- First charge must be available as security
- Maximum loan-to-value (LTV) 65% or a Loan-to-cost of 75%
- Lend to professional developers with at least 5 years’ experience
All property developers and some businesses, including third party lending businesses, are required to provide asset security. The amount of security RateSetter currently holds is £146 million across £122 million worth of loans, giving a LTV rate of 84%. Floating and fixed charges are only included in these figures and not a debenture over a business asset or a personal guarantee.
Commercial lending, constituting 14% of the entire RateSetter loan book, is largely made up of loans to the professional, scientific and technical sector (59%) and the Financial & Insurance sector (16.33%).
Default rates are considerably lower than consumer lending. Notably, lending to the arts, entertainment and recreational sectors could be deemed the least risky with a 0% default rate, across £11m worth of loans.
A number of key learning can be taken from this overview:
- The RateSetter offering is inherently linked to the size of the provision fund.
- RateSetter has never lost a penny of investors’ money with the provision fund covering all defaults to date.
- Lending to consumers, property developers, businesses, and to lending businesses, adds complexity to RateSetter’s business.
- Consumer lending appears to be riskier than other types of lending.
- Default rates at RateSetter are rising and the actual 2015 default rate is likely to exceed the estimated.
From a user perspective, RateSetter may be perceived as very investor friendly, offering only three products to choose from, quick access to money, and a provision fund that automatically matches actual returns with estimated.