11 August, 2017

RateSetter Review: Loan Book Analysis

RateSetter Review: Loan Book Analysis

RateSetter Review

Founded in 2010, RateSetter is a peer to peer lending (“P2P”) platform that matches investors with individuals, business and property related borrowers. RateSetter’s market share stood at 21% in 2016 (check out Orca's industry data), making it one of the “Big Three” platforms in the UK, alongside Zopa and Funding Circle. It has lent £2bn cumulatively since formation RateSetter reports a market interest rate, calculated each day according to the amount of available investor capital (market supply) and the amount of demand from borrowers (market demand). Investors can choose from a “Rolling” investment, where they can access their money early free of charge (in normal market conditions) or for a fixed term of 1 or 5 years. This equilibrium is constantly fluctuating and here at Orca we track these daily changes.

Investors can also try to achieve a better return by setting their rate higher than the market rate. However, this can cause delays in lending your money, meaning it is sitting in cash waiting to be lent, gaining no interest.

RateSetter Review: Provision Fund

RateSetter pioneered the concept of the ‘provision fund’ across the P2P industry. The RateSetter provision fund is central to the platform's offering with the fund covering all defaults to-date. Should default rates rise and the provision fund is consumed, a “resolution event” is called, where all capital is pooled together and repayments are made on a pro-rata basis. This means that investors are exposed to the entire loan book, regardless of the products they have selected.

RateSetter Review: Products

The principle difference between the products offered by RateSetter is therefore not risk, but the interest rate earned, investment term and the early access fees.

NB: Statistics are correct at time of publication – 11/08/17

Rolling 1-Year Market 5-Year Market
Rate 4.0% 3.8% 5.0%
Investment Term Ongoing 1 Year 5 Year
Early Access? Investors can access early free of charge Fees apply Fees apply

RateSetter Review: Withdrawing Funds

The Rolling Market product is designed to provide you with easy access to your money. Interest can be withdrawn as an income or reinvested. You can access your money at any time, providing there are funds available in the market to match the amount being withdrawn. It is important to remember that the underlying loan obligations may range from six months to five years and early access relies on buyers being willing to buy these loans, which under normal market conditions is highly likely, but of course there may be a circumstance in adverse conditions where this is not the case and you have to wait out the term of your loan.

For early access to your money when investing in the 1-Year or 5-Year fixed term products, RateSetter's ‘Sell-Out’ feature is available. This comes with an average fee of 2.02% (which has increased significantly, from 0.72%, since the start of the year) of the underlying investment and usually takes around ten minutes, depending on market conditions.

It is important to note that if you trigger the sell-out feature, RateSetter will offer your loan parts to other lenders to purchase. If a buyer exists and the current interest rate on offer is lower than your achieved rate, RateSetter will keep the difference in the future accumulated interest. If the current market rate is higher than your achieved rate, the deficit is deducted in favour of the new investor. This ensures the new investor is not penalised for substituting your loan commitments.

Also, RateSetter will impose a further charge if you use the ‘sell-out’ figure to access your money early. Your rate of return will be reduced to reflect the amount of time you actually ended up investing for. For example, if you invest in the 1-Year Market and withdraw after four months, you will get the Rolling Market rate.

Ratesetter Review: Net Returns

To estimate net returns, Orca has conducted loan-by-loan cashflow analysis on every loan originated by RateSetter. Providing the RateSetter provision fund has the funds to pay out on borrower defaults, which it has to-date, investor returns are considered to be stable and predictable.

The chart below plots net returns, calculated by Orca vs. estimated net returns provided by RateSetter. In year 2015, the actual performance of the loan book was poorer than expected – 3.61% - however, the provision fund covered all losses so investors’ actual return was as expected – 4.79%.

In 2017, the actual return appears to be higher than the expected return. Loans originated in these years are still in their infancy and so the risk of these loans defaulting later remains significant. Again, as the provision fund covers losses, the actual return will likely be close to the estimated return. Any over-performance will increase the size of the RateSetter provision fund and not be credited to investors.

*Analysis conducted on the Orca Platform

Ratesetter Review: Default Rates

RateSetter does not publish its expected future default rate but does publish its expected future bad debt rate. The bad debt rate takes into account any recovered losses following default.

The actual default rates can be seen to be decreasing from a high of 4.5% in 2014 to 0.24% in 2017. As loans are still in circulation and in their infancy, they still have the opportunity to default in later years.

Bad debt includes any recoveries after the loan has moved into default. By comparing RateSetter’s default rate relative to its bad debt rate we can see the performance of the company’s recovery process. In both 2014 and 2015 actual bad debt rates were higher than originally estimated. As the provision fund covers all borrower defaults this should not be perceived as a significant risk to lenders. The rising default is, however, something that needs to be continually monitored.

Ratesetter Review: Volumes

The amount a platform lends is important for two principal reasons:

  1. Credit Modelling: The more a platform lends the more data it has to build its credit processes. Effectively, the more experience a platform has at lending the better it becomes at evaluating credit risk.
  2. Early Access: To access your money early a new lender/investor must be available on the platform to fulfil your borrower commitment. The more the platform lends, the greater the probability of new lenders.

Cumulatively, RateSetter has lent £2bn, growing year-on-year since being founded in 2010. In the past four years, we have seen significant capital on the RateSetter platform.

Ratesetter Review: Security

The RateSetter provision fund is a vital aspect of the platform’s inner-workings, especially prior to choosing which product to invest in. This is because in the event of the fund becoming depleted, RateSetter would declare a ‘Resolution Event’. This would mean that all outstanding loan contracts, regardless of which product you have invested in, would be automatically assigned to the provision fund and all loan repayments would be assigned to the provision fund on behalf of investors. Repayments would then be shared out to investors on a pro rata basis, i.e the amount you receive will reflect the value of your original investment (if you invest £100 and a 5% loss was applied, you would lose £5).

In terms of risk, therefore, all products are essentially equal due to how the RateSetter provision fund operates.

Due to the significance of RateSetter’s provision fund, it is important to keep a check on the strength of the fund through its coverage ratio (the value of the fund against expected future losses) relative to their actual bad debt rate.

Given that most of RateSetter’s underlying loans are to individuals and businesses, they are unsecured and don’t have the added security that comes with property loans (10% portfolio) and some large business loans which are asset-backed.

Ratesetter Review: Borrowers

RateSetter is the first platform of scale to lend across consumer, business and property borrower types. The mix of borrower types separates RateSetter from other P2P platforms and creates an extra layer of complexity to 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 development loan.

RateSetter uses CallCredit and Equifax to perform credit checks on borrowers. They also use external data feeds from the telecoms industry and anti-fraud tools to assess borrowers.

The minimum, maximum and average loan are displayed in the table below.

Year Min Loan Size Avg Loan Size Max Loan Size
2010 £95.00 £4,501.13 £30,715.00
2011 £324.84 £3,626.15 £25,580.00
2012 £926.30 £4,565.00 £37,075.00
2013 £74.20 £7,620.96 £261,250.00
2014 £22.53 £5,139.89 £1,507,500.00
2015 £51.94 £4,325.17 £1,597,500.00
2016 £5.79 £4,423.65 £1,414,000.00
2017 £51.30 £5,107.31 £1,652,548.65

The relatively low average loan amounts reflect the prominence of small consumer loans across the RateSetter loan book. In correlation to RateSetter starting to lend to property developers in 2014, we can see an increase in the max loan amounts from 2014 onwards.

Year Min Borrower Rate Avg Borrower Rate Max Borrower Rate
2017 1.69% 5.47% 34.49%
2016 2.06% 6.52% 73.92%
2015 1.57% 6.98% 42.24%
2014 1.45% 7.29% 70.71%
2013 1.94% 6.19% 26.97%
2012 2.80% 7.15% 19.28%
2011 3.91% 8.06% 29.69%
2010 2.30% 6.30% 11.75%

The annual weighted average borrower rate of RateSetter’s loan book has reduced from a high of 8.06% in 2011 to 5.47% in 2017. This reflects a compression in yield earned by retail investors. The max. borrower rate in some of the years – 2016, 73.92% and 2014, 70.71% – appear alarmingly high, however these are small outliers in the data set and not thought of as a risk to investors.

RateSetter Review: Conclusion

RateSetter has a strong track record of providing stable returns to investors in line with their estimates, thanks to the value offered by the provision fund. However, there is a trade-off for this security as the platform offers rates of return that are comparably lower to those offered by other major P2P platforms.

It is important to remember that risk is not a differentiating factor when choosing which product to invest in. Instead, return, term and the early access fee are the key features for potential investors to evaluate.

Editor note: This article was originally published 6th October 2016, we have completely refreshed it to provide you with an accurate and comprehensive update.