Big Lending Update On Zopa, RateSetter and Funding Circle

We have had a lot of requests for updates on the big three P2P lending sites, namely Zopa, Funding Circle and RateSetter. There's an awful lot of important things to say about each of them, so here goes:

Zopa Core earns a 4thWay PLUS Rating

As you probably already know, Zopa is retiring its lending products Zopa Classic and Zopa Access for good, along with Zopa's reserve fund Safeguard which covers expected losses. You can no longer lend new money or re-lend your repayments in those lending accounts.

In their place is the new Zopa Core lending account, with no reserve fund, which targets an interest rate after bad debts now of 3.7%. This is marginally down from the recent 3.9%.

Based on 4thWay's detailed assessment of Zopa's loanbook, the overall risks have ticked up in Core compared to Access or Classic, which is why its 4thWay Risk Score has gone up from 4/10 to 5/10 (with 10/10 being the riskiest).

This risk score is due to 4thWay's tough tests that indicate average lender losses before interest in a very severe recession of 5%-10%, up from the previous 2.5%-5%.

However! Due to earning excellent interest for the risks involved, I believe the majority of Zopa Core lenders should expect to recover all their losses within two years – if they experience any losses at all – during even a major recession.

That's based on 4thWay's standard stress tests using international banking standards, but a much tougher version of them than banks are required to do in testing their own loans. It's why Zopa Core earns a 5/5 4thWay PLUS Rating.

If you also re-lend your repayments and interest, it will lower your risks even further. You need to ensure you're lending across at least 100 loans, preferably more. As Zopa points out, expect bad debts to rise at first and then fall as dud loans drop out of your lending and as Zopa makes recoveries.

Zopa Plus also has the top 4thWay PLUS Rating

Zopa Plus is a lending account that has never had a reserve fund. It's not new like Zopa Core; it is already about a year-and-a-half old.

Zopa Plus includes some prime borrowers like Zopa Core, but also a lot of borrowers some good way up the risk scale, which is why it pays higher interest rates than Zopa Core.

The rate that Zopa expects lenders to earn after losses in Zopa Plus has just plummeted to 4.5% from a previous 6.1%. There are possibly two related causes of this sudden plummet:

• More borrowers at the higher-risk end are starting to struggle, so Zopa could be battening the hatches on lending to them. Fewer higher-risk borrowers also means lower average rates.
• Zopa could be forecasting an uptick in bad debts, again, due to the increasing struggles of higher-risk borrowers. That lowers the average expected interest after losses.

Turning to my own assessment of the risks in Zopa Plus, Zopa doesn't make it easy for us to split up its full book of loans so that we can check out Zopa Plus loans distinctly from Zopa Core ones. It is only because of the high quality of Zopa's performance at the higher-risk end that I currently feel I able to do so:

I am confident that the Zopa Plus account also earns a 5/5 4thWay PLUS Rating as we believe it will perform fantastically well in a severe recession, according to our tough modelling.

The 4thWay Risk Score on Zopa Plus is 6/10, making it slightly higher risk than Zopa Core's 5/10, but still below stock market risk. This means that our modelling shows potential average losses of 10% to 15% before interest, but the huge interest rates that Zopa lenders earn from many Zopa Plus borrowers – up to 32% – makes up for this.

Also remember that bad debts occur once but interest is earned over many years, which is very useful at reducing risk of an overall loss.

Higher-risk loans are more volatile, meaning you can be more prone to bad luck even if you are getting high enough interest rates for the risks. This means that you need to diversify more to contain the risks.

Ideally, try to get your Zopa Plus loans split over several hundred loans by staggering your lending and by re-lending the repayments you receive. This massively – extraordinarily – reduces the risks of being unlucky.

Read the Zopa Review.

Funding Circle upends its service – mostly good news

Most lenders using Funding Circle spread their money across lots of loans automatically using Funding Circle's autobid service.

A minority of lenders choose which individual loans to buy and sell for themselves, but Funding Circle is closing its manual lending on 18 September. And it's making a lot of other changes too:

There will be two lending accounts to choose from

Funding Circle will offer a lower-risk option called the Conservative account, targeting returns after losses of 4.8%. This will initially be lending to its A+ and A grades, although I strongly expect Funding Circle to throw in increasing numbers of higher-risk loans to counter a steady trend in falling interest rates at the lower-risk end. (Certainly a trend to watch, but there's no cause for concern at Funding Circle yet.)

Funding Circle's other account is going to be the Balanced account, targeting around 7.5%. That will spread your money across the full breadth of Funding Circle loans: A+ to E grade.

Funding Circle will not introduce a reserve fund to go with these accounts.

You might have noticed that these two accounts are virtually identical to the way Zopa Core and Zopa Plus work.

These changes – especially the removal of manual lending – are an almost wholly positive change for auto lenders and a mixed change for manual lenders. Here are the positives to this change:

• Funding Circle increases its stability as a business. It surely costs Funding Circle a disproportionate amount of money to allow manual lending. Lower costs makes Funding Circle stronger as a business which can only be good news for lenders.
• Some of the savings will probably be passed on to lenders. Currently, to sell a loan before it is repaid by the borrower, lenders pay Funding Circle a sale fee of 0.25%. This is being scrapped. A cynic might say that Funding Circle intends to hide that cost in lower interest rates for lenders, but it is also possible that the P2P lending site is passing on some of the savings it makes in running a fully automated lending platform.
• Autolenders will not lose out on the best loans. A danger with manual lending for autolenders is that manual lenders steadily get better at picking and choosing the best loans. This leaves autolenders with the least best loans. Now, this is not possible, which makes it fairer.
• Enforced diversification reduces the risks. Even pros have not been diversifying enough. The founder of a major website that compares stock market investment funds pooh-poohed Funding Circle after he lost money. Problem was, he just lent in 20 loans. Just 20! To dramatically lower the risks, you need to lend in at least 100 loans, and preferably more, especially if you aren't just focusing on the best borrower grades. To be clear, lending in 100 loans is not five times safer than lending in 20 loans. It's more like 50 times safer. You also have to lend for quite a while, since Funding Circle has a good record of recovering bad debts and those recoveries help boost your results. You will now have no choice but to spread your money across loans.
• Lenders will have even more diversification. Funding Circle will limit your lending to a single borrower to 0.5% of your money, although the minimum loan to a borrower is £20. Put another way, it means Funding Circle will look to spread your money across at least 50 businesses if you lend £1,000 and at least 200 if you lend £4,000 or more. Previously, Funding Circle allowed autolenders to choose to diversify less, so overall I expect this to improve safety.
• Funding Circle predicts your money will be lent faster. I've got nothing to add to that.
• Easier for lenders with lots of money to sell loans. Say you are lending £500 to one business. This will now be split into loan parts of a maximum of £100, so your £500 will be made of at least five loan parts. This makes it easier to sell loan parts to other lenders through the automated resale market.

Here are the negatives for manual lenders:

• You won't be able to enjoy trying to select the best loans to outperform. Manual lending enabled borrowers to select loans to attempt to improve your overall return, largely by lowering the risks. (Although if you were not good at doing this you could have accidentally increased your risks.)
• No more instant wins. Selling your loans on Funding Circle's resale market for more than you paid for them – will no longer be possible; premiums and discounts will be removed.

Clearly, the minority doing manual lending will be disappointed, but they have plenty of other P2P lending sites to choose from.

Funding Circle's lending interest rates change on 30th August

Funding Circle has squeezed the rates of the safest loans a few times already and now it is doing it again.

The rates are coming down on A+ loans again by as much as 1.6% and I believe the main reason is increased competition in lending to small business borrowers.

Higher-risk loan rates will be up as much as 2.6%.

Funding Circle's highly competent team has so far proven to be very good at pricing interest rates and I expect it to continue. We just need to watch that Funding Circle is confident and disciplined enough to keep to sensible minimum rates despite increasing competition.

RateSetter leaves P2PFA: what this means for lenders

RateSetter has just pulled out of the Peer-to-Peer Finance Association (P2PFA) after it breached the principles of the club. The P2PFA is a collection of P2P lending sites that have agreed to common standards, including providing clear and complete information.

RateSetter took unusual actions on several large borrowers recently, including buying them out and deciding to pay for bad debts out of its own pocket, which makes RateSetter less financially secure. RateSetter has left the P2PFA, in particular, because it was not up front about these actions quickly enough.

RateSetter had already admitted its mistakes and in leaving the P2PFA it has now admitted it should have been more transparent about those borrowers earlier on.

I don't feel that RateSetter leaving the P2PFA adds anything to what Neil already wrote about this in Fact Check: RateSetter Hit By £80m Of Struggling Loans.

I believe that RateSetter could have completely hidden the problem even from the other members of the P2PFA by dumping any losses on the large loans that were troubling it into its provision fund. The provision fund is a pot of money set aside to cover expected lender losses, which is topped up by fees paid by borrowers. RateSetter could have quietly added more money to the fund to cover higher losses – which it is allowed to do. It chose to be honest.

It should probably have provided more clear information, more quickly, on these loans. But I feel it has been genuinely contrite and honest about correcting that, when it could have got away with not doing so. This is even though its honesty now has meant leaving the P2PFA, which is so well respected by journalists in the national press.

The P2PFA is a relatively weak criterion for selecting P2P lending sites to lend through

This association, probably like many associations, started off with a high aim: set great standards to prevent widespread lender losses. It has done very well in that regard and continues to do so. It is surely a good reason why the whole industry has survived and thrived beyond its startup stage.

But lenders need to realise that associations, even this one, are primarily marketing bodies – PR mouthpieces. The banks' own association is a propaganda machine and you could say the same about probably all the associations that support unpopular or hated industries. Probably even popular and loved ones too.

The point is that you will never hear the P2PFA say meaningful bad words about the P2P lending industry or at least, in particular, its own members. So it is what it is.

The associations' standards are high and it absolutely needs to be recognised for that. I'm glad it has existed, which is not something I'd say about the British Bankers' Association.

But RateSetter leaving in this way does not concern me. What would bother me is if a P2P lending site left it without giving a plausible reason why or without admitting any fault. That would indicate it was kicked out for something far worse.

Don't rely on membership of the P2PFA when selecting P2P lending sites. It's important to learn how to assess the actual risks at each individual site for yourself and to spread your money across lots of them.

Read more: the 4thWay RateSetter Review, written by one of the UK's foremost authorities on peer-to-peer lending.