How To Assess P2P Lending Websites
You really must read our 8 Core P2P Lending Guide pages for beginners first. But, if you're serious about taking the time to really dig deep into P2P lending, the following guide, How To Assess P2P Lending Websites, will take your understanding to the next level.
1. The key people
Are the loans secured? Is there a provision fund set aside to pay bad debts? Have any lenders lost money? How much money has been lent? How long has this P2P co. been around?
One of those five questions is the first one that most new individual lenders ask when assessing P2P lending companies – but not the professionals. Yes, these are all important and relevant questions. But, when 4thWay's specialists are going in to assess a new P2P lending company, the first thing we want to find out is if they have the right people.
This is not just theory. We've seen it in the banking industry for 20 years. And, in P2P lending, the records of companies that clearly have a lot of relevant experience have been phenomenally better than the rest. If they don't have the right people with prior experience, it could make sense to wait until they have a built up an especially long – and brilliant – record with their own P2P businesses before you lend.
Notice that we put the people above everything else, including interest rates or bad debts. Expert stock-market investors learn that the last thing to do is look at the graph showing the share price, filling you with greedy thoughts before you know whether the underlying business is actually any good. And it's exactly the same whenn assessing P2P lending platforms. It's much more important to get to see what the platform is actually made of – and no part in their works is more important than its senior personnel.
It's a partial piece of the puzzle
4thWay has the great fortune of being able to call or visit top decision makers at many of the P2P lending sites when we need to and we try to share the insights we learn where we can.
You can't as an individual demand to interview their key personnel. Yet, as with any armchair investor (or lender), you can often get a lot of information about the people behind these companies through the internet. It goes without saying that the information won't always be accurate, but it is still a great first assessment of any P2P business and it is the start in building a picture of what they might be capable of.
What to do first
In the first instance, glance at the “About Us” section on a P2P lending company's website and take a look at the profiles. Hopefully they have a lot of details. Yes, again, this is just what they say about themselves, but what they do and don't say can be revealing and it is the start in your assessment of their plausibility.
Credit assessment people
You want to see relevant banking experience at “credit assessment” (or “underwriting” or “loan origination”). This means that they have experienced – and perhaps even devised – the processes they need to take initial applications from borrowers; assess the borrowers and their security using appropriate searches, questions and criteria; and then decide whether to lend and at what interest rate.
Preferably you'll see decades of that sort of experience between all the key people in the management team, but closer to ten years can be acceptable, particularly for types of lending that are generally lower risk and particularly if at least one of the team has been through a recession or other crisis in that role.
Particularly for loans that have historically been regulated, which is most loans but not short-term bridging property or development loans, and also for all types of lending where there are high numbers of loans approved on a weekly basis, you'll want to see “credit-risk” or “risk” specialists.
Sometimes the P2P lending company thinks its quite funky to use the more generic and currently fashionable term “data scientist”, and I can understand that because it does sound a lot more Apple than Lloyds Bank, but you still generally want to see that one of their data scientists has a loan-risk modelling or loan-risk analysis background.
If you see that the risk specialist has a lot of “compliance” experience, that is usually a good sign that he/she genuinely has the risk analysis background you're looking for, although you won't always see that. This means that they help make sure the lender is fully compliant with the UK's financial regulator's requirements.
Why do we exclude short-term bridging and development, you ask? Good question, well spotted. It's because since these loans are unregulated there has been relatively little published data on them for risk specialists to get their teeth into, which is one more reason why development lending is intrinsically riskier than loans secured on property that is being rented out. The loans are also very large, so it takes longer to acquire enough information that risk specialists can get their teeth into. That said, a risk specialist at a development lender is still great to see.
You might want to see, particularly for larger loans negotiated individually, that there is a credit committee of experienced people that agrees whether to approve loans. Or you might just want to see that a particularly experienced person at the top signs off those loans or sets the processes for doing so.
Watch out for coy words
Don’t be fobbed off with “banking experience” or “former banker” or “decades of experience in financial services”. You want to see that it is the actual experience you're looking for, and very preferably in the specific types of lending that the P2P lending platform itself does. It's fine if some of the directors have a background in currency markets or equities (the stock market) but you still want to see the relevant experience too.
Where to look for further information
Frequently you won't get enough information in the About Us section, so get on linkedin to see their profiles. I suggest you search google for the same people. See what you can find out about them on their former employers' websites.
If they claim to have run their own businesses or been directors, you could find the P2P lending company in Companies House (which currently has a free “beta” (i.e. testing) version here, and you could look for them in the Insolvency Register and director search services.
All of us rely on the P2P lending businesses being mostly honest with us, just as investors rely on any fund manager or stock market-listed business to do so in their reports. I hope it goes without saying that you know they can simply lie about their experience, so the more independent evidence you can get that they are telling the truth, the better, and trust your instincts if something smells fishy. Never invest – or lend – without full confidence in your decision.
Sponsors and introducers
Particularly for property or asset lending, it's quite common for P2P lending companies to get their borrowers sent to then from what they call “sponsors”, “brokers”, “introducers” or “partners”.
These could be specialist brokers, which the borrower has approached to try and find them a lender.
Or they could be large businesses that lend their own money on assets or property they understand. Sometimes they want to sell on those loans to you and other individual lenders, so that they then have more cash to deploy elsewhere. To profit from that they either keep a slice of the loan themselves or take a fee (which reduces the interest you earn).
This is all fine. It can also mean an extra layer of scrutiny, since they do a first review of the loan application and borrower. They can be very experienced at assessing borrowers – or they might be inexperienced or passing on their worst deals.
They will usually look to send on borrowers who they are confident will be accepted – so that they don't annoy the hell out of their P2P lending partners.
However, you have to sometimes take that with a pinch of salt. Particularly during tough economic times, they might try it on a bit more. They might feel the need to maintain their loan referral fees even as borrower quality goes downhill and the market shrinks. Remember, they are earning fees from arranging these loans and then passing the risks on to you. So you still want to see that the P2P lending site itself has the skills to scrutinise deals.
Some sponsors continue to lend some of their own money in loans and even agree to take the first loss. Others will even agree to buy back the whole loan if it goes bad. So you might want to look for those additional protections. More on that in a later page.
It is perfectly reasonable for P2P lending companies to outsource key skills to other businesses or freelance experts. I think most typically, it's the risk modelling they outsource. (Indeed, 4thWay's chief risk modeller has already assisted Landbay*, MarketInvoice and ThinCats, among others).
Sometimes they will even outsource an additional check on the quality of a loan or applicant. Unfortunately, they don't always publicise outsourced help. You could always wing the P2P lending company an email for more details. Also our Quick Expert Reviews in our comparison tables briefly evaluate the people and processes behind each P2P lending company, since 4thWay generally has greater access to interview key people, and dig into their real experience, personalities and processes.
2. Security quality
We'll look at security first. Read the info box if you don't know what “security” is and what “secured loans are”.
Security as a backstop
The best P2P lending sites see security as a last resort, not the first. They go for high quality security, but they still look for high quality borrowers who are likely to pay their bills.
This does not go without saying. We know from direct discussions with some P2P lending sites that they are focused very much just on getting great security and we can see from the processes that others use that they rely on security above everything else.
None of us here at 4thWay consider that to be appropriate, since it can lead to too many debts going bad, combined with long bad-debt recovery times and no guarantee of success. We think it either indicates inexperience on their part or a single-minded drive of the directors to grow quickly at all costs – in the worst cases, perhaps, in order to make a quick million for themselves before shutting down.
All of that said, you still should expect high-quality security on secured loans, since it really does give you huge protection from losses.
Here are the key requirements for high-quality security:
If a borrower has a property valued at £100,000 as security and borrows £70,000 then the “loan-to-value” is 70%. This gives lenders a lot of protection.
We think you should normally want to see that a P2P lending website has a maximum loan-to-value of no more than 80% and an average loan-to-value under 70%.
You normally want P2P lending websites to obtain a “first charge” on the property used as security. Alternatively, it might be “held in trust” or, for items like works of art, have a “pledge” against it.
All this means that in the event the borrower can't repay, you are first in the queue when it comes to selling the property to repay the debts. If, say, a bank has also lent to the borrower, the bank will only get repaid if there's any money left after settling your loan.
It also means the borrower can't sell the security without paying you off.
If you have a secured loan with a “second charge”, it means that you are second in line to be repaid.
For example, there might be a first-charge loan for £50,000 and you are lending in a second-charge loan for £20,000. The total is £70,000. If the property is accurately valued at £100,000, the price, including all costs, will have to fall £30,000 before any lenders lose any money.
If the property price falls £40,000 – an extra £10,000 – you lose half your loan. Because £10,000 is half of the £20,000 secured loan. Note that this is still true even if you only contributed £500 towards that loan yourself: you would lose £250.
If the property price falls £50,000 after all costs, you would not get any money back. Just the first charge lenders would receive all their money back.
Note carefully how that differs if you're a first-charge lender lending all £70,000. If the property is sold for £50,000, you get back £50,000 out of £70,000 (or rather your share of it), so that's 5/7ths of the money you lent. So it is safer to be a first-charge holder lending £70,000 than a second-charge holder lending the last £20,000.
You can also get third or fourth charge loans, which are ranked after second charges.
The borrower can't sell security without paying off all charge holders.
No loan-to-value provided
If a secured loans P2P lending website does not generally provide loans-to-value, it is usually because the security has not been thoroughly valued and no charge has been put on it that prevents the borrower from selling or using up much of the security.
You most typically see this with business loans. The majority of the security is often a “floating charge” on whatever cash and stock that the business happens to have on hand at the time it goes bust.
Additionally, there might be a “fixed charge” on specific plant or equipment which cannot be sold. However, it appears to be very common for P2P business lenders not to physically value these assets!
Typically, P2P lending sites describing security as “debentures” or “bonds” won't usually have properly valued assets and you have to assume there aren't so many high-value assets they can put a solid claim to.
Some platforms even have the gall to call “personal guarantees” from the directors “security”. You should consider such security to be highly dubious.
The word “secured” should always be treated with a barrel of salt in all those cases. Internally and in our guides and articles, 4thWay calls secured loans with no LTV and no valuation details “naked security”. This doesn't mean that business loans like those are risky, it just means that you have to consider other aspects than the security to be far more important.
We at 4thWay usually treat loans with naked security the same as we do unsecured loans, until the P2P lending site has a long and successful record in recovering bad debts through repossessing and selling security.
If it isn't rock solid, in your view, give the security no weight.
Subsequent loans ranked equally
It would be hideously remiss for a P2P lending provider not to state when a borrower is allowed to apply for additional loans that will be ranked equally to the existing loan or loans on offer. Thankfully, up to this point, it looks like they do provide this information.
Say there is a loan for £40,000 and the security is £100,000. The loan-to-value is 40%. If the borrower borrows an additional £20,000 and the loans are equally ranked, the loan-to-value is now 60% for all lenders, regardless of whether you lent in the first or second loan. This might be acceptable to you, if, for example, the second loan will only be approved on meeting certain criteria. The borrower might, for example, use the first loan to get a property in a state to start renting some of the rooms, and that rent decreases the risks of lending to the borrower.
On seeing that future loans will be ranked equally, find out what maximum loan-to-value has been agreed. You might specifically have to ask the P2P lending website for this information. When deciding whether to loan, barring special circumstances, we think it makes sense to assume that the borrower will borrow up to that maximum LTV.
You should usually expect professional, independent valuations of security.
For real property – aka real estate – this usually means a survey from a RICS surveyor (Royal Institute of Chartered Surveyors).
For businesses, it is accountants and finance professionals who will assess value based on accounts and management reports.
For plant and equipment, or assets such as fine wine, classic cars and more, you want to see that Sothebies or other respected auctioneers and valuers have conducted the valuation.
If the loan is to pay for a property to be developed it should include a building surveyor or architect confirming how much the project costs. And a monitoring surveyor to keep track at every stage of the development, before additional money is lent to the property developer. (For development loans are usually given in several tranches after developers have met agreed progress.)
No independent valuation
If the security has not been recently independently valued by a professional, there needs to be a good reason.
It is possible, sometimes, that key people at the P2P lending website itself have enough in-house experience to value certain items for themselves.
You might be surprised to hear that it can sometimes be pragmatic and reasonable to use an estate agents valuation, perhaps combined with an older valuation, data from Zoopla, and other sources. This must always be accompanied by very low loans-to-value. We would not expect this to happen routinely and not on loans greater than 50% LTV.
The reason a P2P lending website would do that is to assist a borrower to get the funds more swiftly and so that a good deal closed. It does not mean that the P2P lending site is allowed to be sloppy on its checks, e.g. on fraud and affordability, and it must still see the title deeds or quality evidence that the borrower really owns the property.
Another example of a non-professional, non-independent valuation: when a car is security on a loan and the valuation is based on Glass' Guide. The P2P lending website will not get the Glass' listed price if the security has to be sold at auction, so unless there are other safeguards the loan-to-value should be low – probably below 50%-60%.
If the security has not been physically inspected, again, there usually should be a good reason
Rent received against the security
The gold standard in security is not just a low loan-to-value. It is also security that pays the loan all by itself on a monthly basis.
I'm talking about properties that are being rented out at the time the loan is made.
These properties are variously called rented properties or investment properties. They might be residential buy-to-let mortgages or a commercial buy-to-let mortgages. A commercial mortgage might be secured on offices, shops or industrial units.
All of these properties are being rented out by the borrower to people or businesses.
Ideally, we would really like to see that the rent being received is, for every loan, at least 1.25 x the monthly mortgage payments. We would also expect the average rent to be 1.4 x the monthly mortgage payments.
There aren't many loans secured against people's own houses yet in P2P lending, but it does happen.
People who own their own homes will do everything not to lose them. This is a priority debt for them, which makes the risk of non-repayment low compared to most other kinds of loans.
There is one aspect to be aware of. If some homeowners can't pay and you take them to court, the judge might not necessarily order a home valued at £200,000 to be sold immediately to repay a £20,000 P2P mortgage – especially if there is a family in it. You could wait a long time for your money back. Hence, you still want to spread your money out across lots of loans.
Property development loans
When you see “LTV” next to a development loan, it normally doesn't mean what you think it does!
Normally, it means loan to “gross development value” and should really be written as “LGDV”.
The gross development value is the hoped-for sale price after a property development is successfully finished and sold.
Typically, a loan might be for £800,000 and the hoped for sale price is £1.2 million, giving it an LGDV of 60%.
As lenders, this ratio is, by itself, of very little value. There are so many things that can go wrong with a development project that other factors should be considered.
This doesn't mean that you still can't find excellent and low-risk individual development loan opportunities – and perhaps the easiest way to do that is to look for the real LTV. Meaning find out what the land and property is worth today and calculate the loan size against that.
If the real LTV is under 50%, it's looking good. You do, however, need to make sure the developer is not just about to tear down and destroy the security: is that valuation based on the land only? Or if a building is on it, is it going to be built on and improved rather than bulldozed?
Finally, current valuations are often based on the assumption that planning permission will be approved in the near future, which instantly increases the value of a site, sometimes by tens of millions of pounds. You need to be convinced that this approval is likely to happen, based on reports or comments from committees at the local authorities.
We do see development loans, and other opportunities, at under 50% with interest rates from 7% to 13%, almost every day. These are posted in our P2P Loans Feed.
Are recoveries good?
Some P2P lending sites tend to rely on the security as their main defence against risks. This can mean a lot of loans go bad, leaving lenders having to wait many months or even years to find out how much of their money they're going to get back. It is not good practice. You want to see that secured lenders are even more interested in how good the borrowers are than what the security is like. Business borrowers should be profitable, property borrowers should be experienced landlords or developers.
4thWay's detailed comparison tables handily help you compare the security quality. Just go to the tables, tick the compared P2P opportunities you want details on, and select the “Get more details” button at the top of the comparison page.
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