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How We’ve Improved The 4thWay PLUS Ratings
4thWay's credit-investment specialists, bank risk-modelling experts and investors first developed the peer-to-peer lending and P2P IFISA ratings system in 2014.
4thWay PLUS Ratings incorporate both the rewards – the interest you earn – as well as the biggest risk in P2P lending, namely the risk of suffering losses due to bad debts.
We've just completed a major upgrade to the ratings.
How the 4thWay PLUS Ratings are now awarded
The 4thWay PLUS Ratings are still based on a tougher version of the international Basel tests that high-street banks are required to do, giving lenders such as yourself what we believe to be a large margin of safety if you spread your money across a basket of 4thWay PLUS Rated accounts that include hundreds of loans.
We have reduced the top score to 3 from the previous top score of 5.
Any PLUS Rating is good, whether it's 1, 2 or 3.
Lend across many loans in a basket of +++ Rated lending accounts and we expect the interest most lenders earn by the time all the loans are repaid will more than cover losses from bad debts, if any, during a severe recession and property crash.
Lend across a basket of ++ Rated lending accounts and we expect the interest most lenders earn will cover losses, if any, during a moderate recession and property crash, by the time the loans are repaid.
You could enjoy the benefit of greater diversification by lending in some ++ rated accounts. You might also have the chance to earn higher interest rates.
Lend across a basket of + Rated lending accounts and the interest most lenders earn will cover the losses, if any, during a blip in the economy and property market, by the time the loans are repaid.
Again, you might enjoy greater diversification and higher rates by lending through some + Rated accounts.
Re-lending further reduces the risks
If you re-lend the repayments and interest you receive from a basket of lending accounts with +, ++ or +++ Ratings, you further reduce your risk of losing money overall. Here, we expect most lenders will make a profit over roughly five years, even if you lend through a severe recession and property crash.
Hunt for high value with unrated lending accounts
If a peer-to-peer lending account or IFISA product is not rated, it hasn't passed our Basel tests.
Perhaps it doesn't have a long enough history yet, or hasn't provided us with enough information, or its results have been poor.
Sometimes you'll find hidden gems among unrated peer-to-peer lending sites that just need time to prove themselves. 4thWay's Quick Expert Reviews in our comparison tables could help you to spot them.[/orangebox]
A recap of the first major upgrade
We improve the 4thWay PLUS Ratings over time. Many of the changes are small, but today we launched our second ever big upgrade.
In the first major upgrade a couple of years ago, we progressed from the 4thWay Risk Ratings – a measure of the risks – to the 4thWay PLUS Ratings – a measure of risk and reward.
The 4thWay PLUS Ratings incorporate both the risk and reward. More specifically, the risk of losses from bad debts, as well as the reward you earn in the form of the lending interest rate.
Just a quick two-paragraph detour: at the same time that we progressed to the 4thWay PLUS Ratings, we created the 4thWay Risk Scores, which are a clearer version of the original risk ratings.
The 4thWay Risk Scores focus on just the potential losses from bad debts. In other words, unlike the 4thWay PLUS Ratings, the interest rate is not taken into account. The higher the 4thWay Risk Score, the more loans you might need to spread across to contain your risks, since there is a wider spread of results from individual lender to individual lender.
The 4thWay PLUS Ratings (and 4thWay Risk Scores) are calculated against the performance of the loans in each peer-to-peer lending site's historical book of loans.
The calculations are based on the international Basel stress tests that banks are required to do to forecast bad debts in a variety of conditions, such as recessions. We use a far stricter version of the Basel tests than the banks' somewhat easy target. For more details on the method, see About The 4thWay PLUS Ratings And 4thWay Risk Scores.
The second major upgrade launched today
Now that we have even more history and data, and having taken feedback from 4thWay users about how they understand the 4thWay PLUS Ratings, we have completed our second ever heavy upgrade. Here are the key details:
A five PLUS system becomes three
The most obvious change is this: we've changed from a 5 PLUS system to a 3 PLUS system.
This change is not merely cosmetic, but driven by 4thWay users' request for more clarity and our own realisation that five different ratings, all representing different grades of good investment, is overkill.
As before, any PLUS Rating is good, even a single + Rating, so any peer-to-peer lending or IFISA lending account that has earned a PLUS Rating has passed our tests.
We believe that a basket of P2P lending accounts that all have any 4thWay PLUS Rating is going to be investment grade, by which we mean that the average lender should expect to make money overall, with a margin for safety.
Lower ratings were previously not being awarded
Previously, if you lent in a wide basket of loans from a portfolio of 5 PLUS Rated P2P lending sites or IFISA providers, it meant that we calculated you would earn sufficient interest to recover losses from bad debts, if you suffered any, within two years during a severe recession similar to 2008.
For property lending, we assumed that the major recession coincided with a property crash that led to a 55% hit on the property value when selling the borrowers' property in a hurry to recover a bad debt.
The assumption we made – and continue to make – for the ratings is that lenders lend once in a basket of loans, and do not re-lend the repayments and interest received. If you re-lend your money regularly, even through recessions, your are even less likely to suffer losses. I think of re-lending as perhaps the equivalent of adding one more + to the rating – at least.
(On the flipside, if you try to sell your loans in a hurry during a recession or property crash, that might increase your losses.)
The previous ratings of one PLUS up to four PLUSes were also earned during a similarly severe recession and property crash, but each different rating reflected how much longer it might take, in years, for the recovery to be made, with up to six years to make a recovery with one PLUS rated lending accounts.
However, what we found was that no P2P lending sites earned 1/5 or 2/5 Rating, and very few earned 3/5. This is because the majority of the interest on many loans tends to be earned in the first 18 months, and hardly anything is earned afterwards, because most of the loan has already been repaid.
We also found that peer-to-peer lending products and IFISA products that as a group are actually resilient – and investment grade – were not being awarded ratings at all.
In other words, while we pride ourselves on being cautious, for the lower grades we were simply being too cautious.
How the 4thWay PLUS Ratings are now awarded
The 4thWay PLUS Ratings are still based on the international Basel tests that banks are required to do and how we do those calculations are still as tough as they were previously.
The new top rating is therefore still based on a severe recession and deep property crash, exactly as before.
Now, though, if you lend across a basket of +++ Rated lending accounts, we expect the interest most lenders earn will more than cover losses, if you suffer any, by the time all your loans are repaid, rather than within two years.
In practical terms, this will mean that the lending accounts earning the top rating will hardly be impacted at all by our upgrade. It is lower grades that are affected more strongly.
If you lend in a basket of ++ Rated lending accounts, we expect the interest most lenders earn by the time the loans are repaid will more than cover losses, if any, that are made during a moderate recession and property crash.
Roughly speaking, bad debts could be around two-thirds as much as during the severe recession – on average.
In a major recession the average lender – particularly one who is not re-lending money regularly – might lose money for a time in some of their ++ Rated accounts. But these sorts of recessions are few and far between. We never know when these will hit in advance, but in Basel they are called one-in-100-year events.
In addition, lending and re-lending your money before, through and after a recession should greatly reduce the risk of losses and improve your returns throughout the downturn.
Some ++ Rated accounts offer more opportunities to diversify and they might sometimes offer significantly different kinds of lending. That gives you another form of protection, because while some types of borrowers go through a bad patch, other types will be doing just fine. In addition, you can potentially earn higher interest rates with ++ Rated accounts.
Lend across a basket of + Rated lending accounts and we expect the interest most lenders earn will cover the losses, if any, during a blip in the economy and property market, by the time your loans are repaid.
Most likely, at least some of your lending accounts with a single + Rating will also do fine in more difficult times as well. If not, you will need to consider re-lending through the good times.
We suspect that some of the ++ and +++ Rated lending accounts will sometimes drop to the + Rating when lenders pile in too much, which drives down interest rates. Again, though, you might potentially enjoy greater diversification and higher rates by lending a small amount through some + Rated accounts.
Bargain hunting with unrated lending accounts
If a peer-to-peer lending account or IFISA product is not rated, it means it has not passed our standard tests.
Perhaps the peer-to-peer lending website doesn't have a long enough history to be rated using the Basel method, or it hasn't provided us with the data we need, or its results have been poor.
Whatever the reason that they are unrated, some of these products will end up as disappointments for lenders.
All peer-to-peer lending sites require investigation before you lend, but we believe that unrated sites require a greater level of attention to detail. You will sometimes still find some of the most exciting opportunities here:
If you do some digging, sometimes you'll find hidden gems among the unrated peer-to-peer lending sites, because they have very attractive skills, processes and early results. These are likely to become rated when they have a big enough history and in the meantime they can pay high interest rates to compensate you for the greater unknowns.
Alternative ratings are unaffected
We sometimes award alternative ratings for P2P lending sites that impress us, even though we do not have enough data to give them a proper rating. Those alternative ratings were not affected by this upgrade.
The 4thWay® PLUS Ratings are calculations developed by professional risk modellers (someone who models risks for the banks), experienced investors and a debt specialist from one of the major consultancy firms. They measure the interest you earn against the risk of suffering losses from borrowers being unable to repay their loans in scenarios up to a serious recession and a major property crash. The ratings assume you spread your money across hundreds or thousands of loans, and continue lending until all your loans are repaid. They assume you lend across 6-12 rated P2P lending accounts or IFISAs, and measure your overall performance across all of them, not against individual performances.
The 4thWay PLUS Ratings are calculated using objective criteria that can be measured and improved on over time, although no rating system is perfect. Read more about the 4thWay® PLUS Ratings.
Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.
We are not financial, legal or tax advisors, which means that we don't offer advice or recommendations based on your circumstances and goals.
The opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by ESMA or the FCA. All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.