Cutting out the bank as middleman

2014-08-24 15:00

Research and experience on peer-to-peer lending has found that people are less likely to default if they are borrowing from individuals than from a bank

Peer-to-peer social lending is a growing global phenomenon that links borrowers and lenders directly, bypassing banks and their fees.

It is a similar concept to crowdsourcing, except that instead of a business proposal, a borrower lists needs for a personal loan and investors decide if they want to commit funds based on a specific return rate.

While the model is aimed at lowering borrowing costs and providing better returns to investors, it is not to be seen as a solution for people with poor credit records to get easy credit.

Laurens Pohl, the country head of Lendico South Africa, an online peer-to-peer banking service launched in South Africa earlier this year, says the company applies very strict credit criteria.

“We have a similar underwriting process to the banks, but have stricter criteria. If a borrower doesn’t pay and an investor experiences a loss, they won’t return, so it is very important to us that we do not become a place for blacklisted individuals to get a loan. We are an alternative for creditworthy people looking for lower interest rates or to consolidate their debt to decrease their interest rate,” says Pohl.

Lendico applies a strict underwriting process that includes all credit data such as payment profiles and credit scores, as well as an algorithm that analyses other data collected through social media, such as career profiles and the amount of time a person stays in one job.

“If a borrower has defaulted, their application is automatically rejected. They have to have a clean record. We are not a payday lender or a reckless lender,” says Pohl, adding that the challenge is finding quality loans because around 90% of all applications are cancelled due to poor credit records.

The other challenge is finding investors because it takes time to build up trust. But according to Pohl, thus far all the loans that have been verified on the platform have been funded, although Lendico does support loans with its own capital if it is short of investors.

The average size of the investment is currently R5?000 and Pohl says they encourage their investors to diversify their portfolio across several loans so if there is a default, their entire capital is not at risk.

In terms of defaulting, Pohl says this market segment has a default rate of 4%, but by using an algorithm and stricter criteria, Lendico hopes to reduce this figure.

So far, 35 loans have been processed since the launch in April this year and they have experienced no defaults.

Should a default occur, Lendico has a system in place to try to rehabilitate the loan and does not penalise the borrower.

“We take care of the collection for the first 90 days and try to get them back on track. If that fails, we sell the loan to a debt collection firm and refund the investor what we sold the loan for, which is usually around 30% of the value of the loan,” says Pohl, who emphasises that Lendico does not make its money from fees earned on defaults.

“Normally, if you default, the credit provider increases charges and earns fees on your late payment. We don’t do that at Lendico. We see this as a mutually beneficial relationship and don’t add any penalties for late payment.”

Research and experience on peer-to-peer lending has found that people are less likely

to default if they are borrowing from individuals than from a bank.

“It is similar to the stokvel concept. It builds on trust and has similar social principles,” says Pohl.

How it works

A borrower’s requirements are posted on the site once they have met the lending criteria. Investors can then “invest” in the loan and earn an interest rate based on the quality of the loan.

Loans are categorised according to their risk profile and offer different interest rates to investors. Class A loans offer rates of 8% to investors, while Class B loans offer 9%.

For example, one customer raised R32?500 for his brother’s education. He qualified for a two-year loan at an interest rate of 11.42%.

The investors will earn 9% interest, net of costs, on the loan, and receive both capital and interest payments each month over the two-year period. Pohl says most investors choose to reinvest this monthly payment into other loans to diversify their investment.

Borrower costs: You can apply for a loan for free and only once the loan is approved and fully funded will you pay any fees. There is an initiation fee based on the National Credit Act of R150 plus 10% of the loan value up to a R1?000 limit. Unlike other service providers, there is no monthly service fee.

Investor costs: The investor fee is equal to 1% to 3% of each monthly payment, depending on the loan. The interest rate earned is net of costs.

What do the numbers say?

If you have a good credit history, peer-to-peer lending could provide you with cheaper credit.

But as an investor, you need to ensure that the type of investment meets your investment needs and that you are fully aware of the risk.

If you have only invested in one loan and the person defaults, you lose a portion of your capital. You need to decide if you are being adequately remunerated for this risk.

It is important to understand the nature of the loan repayment and that you would not be receiving 9% per annum on the total value of the loan as the loan capital is paid off monthly, therefore, you cannot make a direct comparison to a normal fixed deposit.

For example

.?If you invested R5?000 into a Class B loan, with a higher-risk profile earning 9%, you would receive R228 per month for 24 months. By the end of the period, your total capital and interest payments would be R5?472.

.?If you were to reinvest your monthly returns, both capital and interest, at the same 9%, you will receive R5?982.10 at the end of the 24-month period.

.?If you invested R5?000 into a Capitec bank account earning 4.5% that paid out the interest each month, you would receive R18 interest per month. If you left the money invested for two years, you would have received a total of R432 in interest so capital and interest would come to R5?432.

.?If you invested R5?000 into the RSA Retail Bond fixed for two years at 7.25% and reinvested the interest, at the end of the period you would receive a final payment of R5?777.

This money is underwritten by government so it is probably the least risky investment available.

These figures show that in order to benefit from the 9% rate, one would have to continuously reinvest the monthly payment into new loans.

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