Published: 15th July 2015, 10:00am 30 mins Peer to Peer lending...

Published: 15th July 2015, 10:00am
30 mins
Peer to Peer lending looks set to explode in Australia, but how big will it have to get to truly disrupt the big bank models? Alan Kohler speaks to RateSetter CEO Daniel Foggo about what sets his company apart from other P2P models.

THIS IS AN UNEDITED TRANSCRIPT
AK: G’day. Welcome to another Eureka Interactive session and as I mentioned yesterday, I want to do a series of interviews and discussions about peer-to-peer lending because not only are they good for or potentially good for borrowers but they’re also all about lenders receiving… lenders getting yield. And so it’s just a potential thing for you to possibly invest in where you’re actually directly lending your money to a borrower using the peer-to-peer lender as an intermediary, and potentially getting a decent yield. So the question is how safe is it and what’s the yield and so on? So it’s all about risk and return. So today we’re going to talk to Daniel Foggo who is the local head of RateSetter which is a UK peer-to-peer lender that’s opened up in Australia. Thanks for joining us Daniel.
DF: Thank you, Alan. Thank you for having me.
AK: How long have you been operating in Australia now?
DF: We’ve been operating or available to consumers since November last year. We’ve actually been on the ground for about three years. It took us some time to work through the regulations initially.
AK: Now, the thing about peer-to-peer lending is that there are a number of models, there are a number of ways to do it. The most kind of well-known ones I think are the Lending Club in the US and Society One in Australia, but my sense is that they have become more providers of wholesale money from, say, hedge funds and super funds and so on to… so they’re not really peer-to-peer, those ones, whereas I think you are much more peer-to-peer. You’re taking money from people such as Eureka Report subscribers, individuals, looking to lend some money.
DF: That’s right. We’re very much more consumer focussed and more peer focussed, so when we think about our business in Australia, all of our lenders are retail investors. In the UK about 95 per cent of our investors are retail investors, the other five per cent is mostly the UK government. So what we’ve seen in the US is a migration really away from individuals and peers towards sort of more sophisticated investors.
AK: Give us a sense of the size of the business in the UK. What’s the size of the book?
DF: The size of the book in the UK is about £400 million. We’ve matched about £650 million. So I think what’s important is on a run rate basis or every month in the UK, we’re matching about AU$90 million. It’s early days in Australia. We’re currently matching about $2 million here, but hopefully in the next, you know, two years or three years, four years we’ll be achieving the same sort of volumes as the UK is achieving now.
AK: Well yeah, I mean it’s just starting out here.
DF: That’s right.
AK: But the Australian business pretty well matches what’s being done in the UK.
DF: Yes, absolutely. We’re following exactly the same growth trajectory as the UK.
AK: No, but the model here is the same.
DF: And the model is exactly the same. And really with our model what we’ve sought to do is to make peer-to-peer lending as simple as possible for investors and hopefully as safe as possible, so it is, as you alluded to, it’s a different model to, say, Lending Club in the US. And so we rarely take a lot of that credit decisioning [sic] and bring it in-house to RateSetter, so that when someone wishes to invest it’s a very simple decision for them. They just have to determine the term they want to lend for – one month, one year, three years or five years, the amount they want to lend and the rate at which they want to lend. And so we have very clever dynamic markets where lenders and borrowers effectively set the rates, so lenders determine the rate they want to lend at and when there’s a borrower demand, they’ll be matched; a bit like a stock market really.
AK: Okay. So tell us, in the UK and here, what’s the average rate that investors are getting?
DF: The rates here are much higher than they are in the UK and I think that’s partly because of the yield curve in Australia being slightly higher, but also because the UK business has now been around for nearly five years, so there’s a lot of trust from the investors and in terms of our ability to manage credit. So in Australia if one lends for about… for one month, the return is about 3.5 per cent to four per cent; if you were lending for five years, it’s about 10 per cent at the moment. So they’re quite healthy returns and the way we encourage people to think of investing on our platform is it’s not a bank deposit – it’s not risk free like a bank deposit – and it’s quite different to equities which can be much more volatile. I think we sit somewhere in between.
AK: But the one month rate of 3.5 per cent to four per cent, that’s per annum? That’s annualised.
DF: Annualised. Sorry. Yes, these are annualised returns. That’s right.
AK: Right. So what is it in the UK, did you say?
DF: The UK is somewhat lower. I think their one month market at the moment is a little below three per cent and their five year market is at about 5.5 per cent. So really that’s about building trust from your investors and so we do a lot of things to make sure we do build trust. We disclose what our expected defaults are, what our actual defaults are. We actually released our whole loan book in the UK only a month or so ago, so that people can really understand that, you know, we understand credit. We know how to manage that risk.
AK: When you say you released the loan book, what do you mean by that?
DF: We released all of the data publically, not the names of the borrowers and so on, but you can actually see the performance of the loan book and there’s great transparency there. And so I think what people are understanding is that we’re provisioning enough and we’ll come on to that model a little bit more.
AK: Yes, we’ll come on… I think the important thing that everyone is going to want to know is the safety element and how you’re providing for that.
DF: The safety.
AK: Michael… The questions are beginning to come through, thanks very much. But Michael says, can I do this for my SMSF?
DF: Yes, absolutely. So what we find… At the moment, you know, we have SMSF investors. I think over time we’ll probably have quite a significant proportion of our lenders will be SMSF investors, particularly at that five year lend market because the returns are really quite healthy and people are investing for a longer term. In the UK about 20 per cent of our investors are over 65 and the UK government just made peer-to-peer lending ISA friendly or pension investment friendly and so we’re expecting significant inflows from, you know, retiree funds over the coming years.
AK: How did they do that?
DF: They basically created a new pension class, so you used to just be able to put shelter money in to either bank deposits or in to shares, but now you can put your money in to a peer-to-peer lending platform and that would be tax free in the UK.
AK: Right.
DF: So, you know, it just shows the endorsement that the sector is getting from overseas.
AK: Well, you said in fact before that the UK government provides five per cent of RateSetter’s money in the UK. What’s that about?
DF: Yes. They’ve lent about £10 million through our platform and that’s really one of the government initiatives over there is to encourage lending, particularly for small business purposes, so primarily that was lending to individuals for business purposes. So the government there is despite owning, you know, or being the largest shareholder in two of the largest retail banks is doing, you know, all it can really to encourage businesses like ours to prosper, and that’s one example.
AK: So Eddie says, I don’t want to be a downer, but what is the worst case scenario here? What are my chances of losing my investment if the borrowers just disappear? So that brings us to the question of how you organise that.
DF: Our structure. That’s a very good question. What we do is every borrower that takes out a loan from RateSetter we assess their credit characteristics and we assess their propensity and ability to repay their loan and the amount of their loan and obviously the term of their loan. And on the basis of that information, amongst other information about the borrower, we will assign what we call a risk assurance charge and that’s an amount of money that goes in to our provision fund. So that’s held separate from our own funds. It’s held by Perpetual, a trustee, and that money is there to protect investors in the event of default.
AK: And what’s the amount of that? What’s the percentage?
DF: So at the moment our provision fund in Australia… It’s obviously early days for us. We have a loan book of about $6.5 million. Our provision fund has about $430,000 in it, so as a proportion of our loan book, it’s quite significant. Now, we expect our defaults at the moment to be about 1.5 per cent of our loans or loans outstanding, so we’ve more than provisioned enough to cover what we expect defaults to be. So going back to the question, really it’s about making sure that we are capable of analysing the…
AK: But the borrowers pay this assurance fund amount, right?
DF: Yes, they do.
AK: And what percentage is it for them?
DF: For them? Well, it’s really risk adjusted pricing, so it depends on the risk of that borrower… that that borrower represents and their loss given default.
AK: So what’s the range then?
DF: So ordinarily for a very, you know, safe borrower, it’s somewhere around… Well, it’s actually as a proportion of their loan. If you were taking out a $30,000 loan, it could be quite a low number, so as a percentage it can actually be under one per cent and then, you know, broadly up to about… on average about three per cent of the principle of the borrower’s loan.
AK: As a once off payment?
DF: Well, it’s paid over the lifetime of their loan.
AK: Paid over the lifetime of the loan.
DF: Yes, but it’s received upfront in to the provision fund at the start of their loan process.
AK: Right. And I guess that’s tied in with your credit assessment process. Tell us about that.
DF: Yes. So look, our underwriting processes are very similar to what a bank actually does in many ways in terms of the diligence we undertake. We just use technology and really efficient processes to make sure that we lower the cost of that underwriting, that we make that underwriting very fast and efficient. So we still have a very manual touch in terms of we always speak to our borrowers before we approve them. We use the government online verification system to make sure that the borrowers are who they say they are. We use credit bureau information.
AK: So do you use their credit rating?
DF: Yes, we do use their credit rating.
AK: Right. So you have to buy that I guess, do you?
DF: Yes, we do. We actually spend quite a bit of information on credit data. So we’re very data focussed.
AK: Quite a lot of money.
DF: Sorry. We spend quite a lot of money on data. So we are very data focussed and we are very focussed on making sure that we get that credit right; that we provision appropriately, and we invest very heavily in doing so.
AK: So would you say that your credit checking processes are more or less thorough than a bank’s?
DF: I would say that they’re actually quite substantially more thorough. We work in one office and so that decision making isn’t sort of quite rigid in terms of, you know, do you fit this criterion and therefore will we lend to you? We have much more sort of flexibility around the risk and how we price that risk and who we lend to. It’s not dictated by boxes. And so our experience so far has been exceptionally good. In the UK of the £650 million or so that we’ve lent, our default rate is less than 0.8 per cent and that’s not annually, that’s over the lifetime of the loans.
AK: So what do you mean by defaults? You mean that people have simply not paid?
DF: That’s right. Yes.
AK: What’s happened to them? Has there been a repossession of their assets in some way?
DF: In some instances, yes. So we do do secured loans and unsecured loans, so in some instances there will be a repossession.
AK: So some of your loans are secured and some are not secured. In what proportion?
DF: So in the UK we’ve been facilitating secured loans for quite some time. In Australia I think today will be the first day we actually make secured loans. We’ve just worked through the licensing process with ASIC. And Carsales is one of our investors, so obviously we’ll be moving towards financing more cars and automotive finance and so we expect to make quite a significant proportion of our loans secured loans.
AK: Right. And is there another figure… So there’s 0.8 per cent in the UK of defaults.
DF: Yes.
AK: Is there another figure of arrears?
DF: We actually report all of this on our website which is a great thing about our business. There’s a lot of transparency there, so you can actually see how many loans are 30 days in arrears, 60 days in arrears and coming up to 90 days or beyond 90 days. In Australia, like I said, we’ve matched or lent just over $6.5 million. We’ve only got two loans that are in arrears at the moment and we haven’t had a default, so it’s a very strong credit performance and really that’s reflective of the types of borrowers that we’re lending to. We’re really making sure that we’re responsible in terms of who we’re lending to and we take the credit risks very seriously.
AK: Okay. We’re getting quite a few questions here from the audience, quite a few. Kath says, can I just choose to fund loans to borrowers with good credit ratings?
DF: So under our model, because you’ve got that provision fund protecting you from defaults, we’ve simplified that process for the investor, so that they don’t choose the loans that they fund. We do that for the investor. So if you lend $10,000 on our platform, in all likelihood you’ll be lending to a number of different borrowers, but you shouldn’t…
AK: Oh, so you’re not actually lending to a single, individual… nobody is actually is lending to one person?
DF: It may be, depending on how much you lend, what borrow orders come through and so on. When you get repayments from the borrowers and you reinvest those repayments, you’ll be lending to different borrowers. So, you know, on average in the UK I think our lenders are matched to about 90 different borrowers. In Australia, it’s earlier in our process or stage of life, so it’s lower than that. But what you benefit from is the provision fund protection and all borrowers pay in to that fund, so really that… the risk of the individual borrower is removed. The real risk that the lender should be pricing is more of a systematic risk; it’s not the risk of the actual individual.
AK: Right.
DF: Well, that’s the way we’d describe it.
AK: What are the fees for lenders?, says Dan.
DF: The fees for lenders are 10 per cent of the interest return that they receive. So when one goes to our website and you see the returns and the returns I’ve been quoting today, they’re actually post our fees. So if you lend $10,000 and the interest rate is seven per cent on our website, really the interest rate is 7.7 per cent.
AK: That the borrower pays.
DF: That’s what the borrower has paid in interest. That’s right.
AK: And you’re getting a fee from the borrower as well?
DF: Yes, we also charge the borrowers fees. Our fees are very light and it is a very light fee model and so scale is obviously important in this industry. We charge our borrowers $200 to $300, depending on the term of the loan, which covers the underwriting cost and some other costs. But if you think about our business and, you know, you think if we had a $100 million loan book and the average interest rate was, say, seven per cent, that’s $700,000 of fees, so it’s actually quite a… you know, it’s 0.7 per cent in that example, so it’s quite light in terms of fees to lenders and in terms of, you know, these sorts of investments.
AK: Someone else says, Anonymous says, what’s the borrowing limit?
DF: The borrowing limit is on our website, $35,000, and we’ve actually just increased our scope to lend in certain instances up to $55,000, but we haven’t actually lent beyond $35,000 at the moment, so that’s really the core focus for our business is $2,000 to $35,000.
AK: And is there a limit on how much an investor can put in?
DF: No, there’s not. I think… What is typically the experience of the investors in Australia, they ordinarily try lending for a shorter period of time with a smaller amount of money, often that’s $100. They then get their money back and enjoy the experience…
AK: Oh, so you can start off with $100, can you?
DF: You can start off with $10 actually, yes.
AK: Ten dollars?
DF: Ten dollars. There we go.
AK: There you go.
DF: So it’s very easy to give it a go and just experience that and actually see a lot of the data that we provide. People will often come back later and put more money on the platform. You know, what we don’t want it people’s money sitting idle on our platform waiting to be matched if they go and put, you know, $10 million on the platform whilst we’re waiting, you know, for the borrowers to come through when we’re only matching, you know, $2 million a month at the moment. So it does lend itself to the lenders putting in more money over time as we build in scale.
AK: Right. But when you put your money on to the platform as an investor, you can determine… you could say this is for one month or one year or two years or five years.
DF: Yes.
AK: And you can and should determine or state your interest rate.
DF: Yes, absolutely. You need to state your interest rate. We can’t make the decision for you. So if you lend on our three year market, you will actually see the lending orders of other lenders or other investors and so it’s…
AK: Oh see, so it’s a transparent market?
DF: It’s like a transparent market.
AK: It’s like a stock exchange situation.
DF: Exactly. So you might see, you know, someone’s lending $3,000 at 7.5 per cent. There might be 10 orders at 7.6 per cent which accumulate to, say, $40,000 and so you’ve got a choice: you could actually put your money lower and you’ll be the next lender matched or you could put it higher with the expectation that we’ll have borrower demand during the day that will, you know, eat up those orders, if you like, so…
AK: But you could say, I’m only prepared to lend at eight per cent…
DF: Yes.
AK: …and you just sit there and wait for someone to be prepared to borrow at eight per cent.
DF: You can sit there and wait. Absolutely.
AK: And is it the case that… I mean usually in these situations, you know, the higher the return or the higher the rate, the greater the risk.
DF: Yes.
AK: Is that the situation? If I was to put my money up on your platform, just say, and say, I only want to get nine per cent, that’s it, and if I actually got nine per cent, does that mean my money’s being placed with a more risky borrower?
DF: No, not at all. So the rate at which you’re lending does not correspond to the borrowers that your funds are matched to. That is an automated process. We don’t choose or determine, you know, rates versus the borrower risk, if you like.
AK: Right. But you can see on your website what the rates are, the going rates are for various terms are?
DF: Absolutely. It’s absolutely live data, so the moment a borrower’s order is matched to lender money or, you know, lender’s money is consumed in our lending market, there are live updates on our website as to what the last match rate was. You can go on as a lender and you can see exactly where all the other lender orders are. We provide historical data, so you can see how rates have evolved since our inception.
AK: Which I suppose gets back to what you were saying before which is that you can’t really… as an investor can’t really choose your level of risk on your platform.
DF: You can’t. No, you don’t choose the level of risk, so you’re not choosing A loans to G loans. We’ve really simplified that process.
AK: Yeah. So what you’re doing is you’re lending on your platform, you’re choosing a term and a rate. The rate has to be within or roughly at the rate that the market is…
DF: Around the market rate, yes.
AK: Around the market rate, but you can’t say, I want to have a lower risk lending profile and I’m prepared to accept a lower rate. You can’t do that.
DF: No, that’s right. That’s not our model, no. Our model is really made to be a sort of more simplistic investment and so we’ve done that for many reasons, but one is you don’t have to choose different risk categories and understand what those risk categories represent. You also hopefully if we provision appropriately don’t have to worry about defaults and so you don’t have to, you know, invest in G loans and think, well, my expected defaults are three per cent or four per cent and in a recession my return is lower. We try to bring all of that analysis in-house.
AK: Peter says, where does the provision come from? Why do you do that as I thought I would just expect a proportion of my loans to default?
DF: Yeah, so and really that’s a different model. That’s more the Lending Club model where, you know, you do expect a proportion of your loans to default. What we’ve tried to do is make it so that when you see a return of, you know, 10 per cent in our five year lending market, you know, our primary goal is to make sure you get a return of 10 years if you lend in our lending market, so that we provision enough to cover all defaults. So it’s quite a different user experience. So hopefully you don’t have to constantly be worrying about, you know, what the defaults are on your loans. You know, what is relevant is our provision fund and whether we’re provisioning appropriately.
AK: Well, without the provision fund, in fact, the onus is then on the investors to ensure that they have diversity.
DF: That’s absolutely right, yeah, so that’s very relevant in that Lending Club model.
AK: Bruce says, realistically what size does your loan book need to be before SMSF investors can get enough loans and enough risk diversification for it to be viable?
DF: Yeah. So we have SMSFs investing on our platform and, you know, some are investing $200,000 or $300,000 via their SMSFs, so there’s certainly enough volume to get scale now and to access lots of different borrowers. So you can access… You know, obviously you can be exposed to lots of different borrowers through lending those amounts. You can also… You’ve obviously got that protection from the provision fund as well. So, you know, I don’t think it’s too early to be investing SMSF money over our platform. We’re actually speaking with various SMSF platforms and so we’ll hopefully streamline that process for investment. But you can actually come to our site and we have it tailored, so that you can actually online register your SMSF and start lending the next day.
AK: Right. Murray says, you have a provision fund. How does it work? We’ve already said that… We’ve done that, Murray, and it’s basically it’s a risk adjusted percentage of the borrower’s payments or interest payments that are paid in to the fund and the riskier the borrower, the more is paid in to the fund. And so I think what you said you’ve got a fund now of $430,000 which is… What percentage of that is that of your current book?
DF: Of our loan book, a little below seven point something per cent I think, so it’s quite significant.
AK: It’s much more than your…
DF: Expected defaults. That’s right.
AK: …expected default rate.
DF: We’ve got over 250 per cent of our expected defaults in our provision fund, so we think we’re quite well placed.
AK: And do you expect to retain… to keep it at that sort of level?
DF: I mean our longer term ambition is to make sure that there are two or three times’ more money in that provision fund than there are in expected defaults.
AK: So realistically is the risk to investors that at some point your provision fund does not meet… is not enough for the defaults, right?
DF: That’s right. That is the risk for investors and so…
AK: And so really your defaults would need to… at the moment your defaults would need to be above 7.5 per cent in order for there to be problems.
DF: Exactly.
AK: I suppose that’s the recession risk, really.
DF: It is and so we’re very transparent around what those risks are. You obviously have visibility from late payments and so on, but more importantly I think we will over time be disclosing, you know, and stress-testing on our loan book, so that people can actually see, you know, in a certain recession what would actually happen. And so we’ve done that in the UK quite regularly as well as releasing our whole loan book, so that people can do their own analysis, but we’ve also presented different scenarios where unemployment reaches X or, you know, basically run the same analysis that banks will run and show what the outcome is with our provision fund. So they’re the sorts of things we quite enjoy doing and they’re the sorts of things that I think investors quite like to see as well.
AK: There are a couple of questions that are kind of on the same theme, one from Sam who says, we’re hearing all the time that peer-to-peer lending will be a major bank disruptor. Will this prediction ever come true? And what kind of growth are we looking at? Joyce wants to know, is there actually a demand for peer-to-peer lending in Australia? Are the banks not providing credit, consumers not happy with the banks’ rates? I’m not getting the point of it for borrowers, so will there be enough demand for investors?
DF: Yes. I mean we’re very confident there’ll be enough demand here and that the industry will grow to scale. I mean if we look at the personal loan market where peer-to-peer lending is really starting in this country, if you think of the spread within banks between deposits and personal loans of, you know, two per cent or thereabouts on deposits and personal loans from 14 per cent to 20 per cent, if you take the, you can call it, average of the 14 per cent spread, that’s a very large spread and that covers a lot of bank profits. It covers a lot of bank overhead. So really this an efficient model where we strip out a lot of those costs, use really efficient processes to bring that spread between the investor and the borrower to be much tighter and through doing that, we think we can give the investor a really good return, but also the borrowers a really good rate. So to date, our borrowers are typically borrowing at rates, you know, anywhere between... Well, there’s a large range, but typically four per cent to six per cent below what they might otherwise get from a traditional lender. So that’s very attractive for the borrowers. And so there are also other attractions for the borrowers. They can repay at any time without paying any early repayment fees. They can get a rate estimate from us without actually having their credit score. It’s also a very seamless process for them; they can apply and be actually approved in the same day and have their funds the next day. So there are lots of reasons why borrowers will come to us and we’re pretty confident in this market. We already know there’s lots of investor appetite.
AK: So what sort of borrowers have come to you? Tony actually wants to know, what types of loans are you making in the $6.5 million or so that you’ve lent already?
DF: Right. So loans from six months to five years, the primary purpose to date has actually been for automotive finance.
AK: To buy a car?
DF: To buy cars. In the UK that’s the same experience we have over there. A significant proportion of our loans are automotive. And home improvement I think is the next most common. And then it’s really, you know, it’s all the reasons that people take personal loans after that. So yes, quite a broad range of loans and we certainly think that it’s an attractive proposition to borrowers and to date, they’ve had a really good experience with RateSetter. We’ve had 23 reviews on ProductReview.com.au and every one of them has been five stars out of five stars. Our job is to make sure we’re only lending to the right borrowers and I think we’re doing that very well.
AK: Ben and Pam are asking about risk profiles. We’ve already kind of covered that, Ben and Pam, where we’re saying that you don’t actually get to choose the risk profiles of the borrowers. What you’re doing is your money is going in to a pool and…
DF: Well, actually not really in to a pool. Your money is directly to match to borrowers, so we do this through a… you actually have a… we’re structured as a managed investment scheme. You as an investor have your own sub-trust. Your trust has direct economic rights to specific loans. So there’s definitely an economic interest to the loans that you’re specifically matched to. But, as you were saying, you do get the benefit of that diversified risk through the provision fund.
AK: Yeah. Well, I think we’ll just have to leave it there, Daniel. Thanks very much. We’ve run out of questions. I’ve run out of questions. It’s been very interesting. If you’ve got any further questions on this subject, well, firstly keep watching. I’m going to do all of the peer-to-peer lenders I hope over the next couple of weeks for you, so you can understand each of the business models that’s on offer and hopefully at the end of it, we’ve all got an understanding of how it all works. But thanks again to Daniel for coming in.
DF: Thank you, Alan.
AK: And thank you for watching.