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My “A+” Funding Circle Loans Are All Going Bad

Question from anonymous 4thWay reader

“I have been investing in P2Ps for a number of years now. These include RateSetter, Zopa, Lending Works* and Landbay*. My experience across all four has, in general, been good.

“Last November I invested £8,500 with Funding Circle for the first time, using their autobid tool. Following their advice to minimise risk I chose the lowest risk bands A, A+ and B, with a maximum exposure of 0.5% to any one loan and spread across over 100 loans.

“After just a few weeks I was disappointed to see a loan default but not overly concerned. However virtually every week another loan defaults. My projected annual interest rate now after fees etc is just 2.3% and if this trend continues I will make a loss!

“I have contacted Funding Circle several times to see if they can explain why so many of my loans are defaulting and my projected interest rate is so low. Interestingly, the majority of the loans defaulting appear to be in the supposed lowest risk band A.

“However Funding Circle say that I am just unfortunate, deny taking on more risk or that their model has changed.

“I am concerned that with the increase in the number of investors Funding Circle are not being so careful as to whom they lend to, in order to meet the demand, and that the statistics that they quote for the interest rates investors can expect are outdated and over exaggerated. I wonder if anyone else has reported the same experience or if you feel this is worthy of further investigation?”

4thWay's view

It's great to see you're spreading your money across lots of platforms and loans. You confirmed to me that you are lending in around 200 loans and no single loan has more than 1% of the money you're lending through Funding Circle.

I think the issues that concern you are whether your results are by chance or whether the level of bad debts you've experienced is widespread, as well as whether you should prepare to make a loss.

Looking at Funding Circle's overall performance, more loans have started to go bad.

20 in every 1,000 A+ loans are either late, have been referred to the bad-debt recovery team, or have been written off. Nine months ago, it was just 14 loans in every 1,000.

Now, armed with those figures, the Daily Mail would probably write “FUNDING CIRCLE BAD DEBTS UP OVER 40%!!!”

The reality is that 20 loans per 1,000 is still well within what we'd expect when lending to the cream of small businesses. The small move of six loans per thousand is also well within natural variations that could be caused by lending to different businesses at different times in different economic conditions.

Of the A-grade loans, 45 out of 1,000 loans are late, in recovery or written off. This is barely up from 42 out of 1,000. A-grade property development loans have suffered more problems than we would like to see at this grade, but Funding Circle appears to be on top of this: it recently announced it would start grading some new development loans as B that it used to grade as A.

The B-grade has seen 67 out of 1,000 loans suffer issues, which is again just a tick higher than the 62 out of 1,000 we recorded nine months ago and not something to worry about.

Based on these results, I see no cause for concern for the average lender at these three Funding Circle borrower grades.

However, with over 50,000 people lending through Funding Circle, it's not surprising that some are disappointed or even worried with their results, just as you are.

Funding Circle has admitted that 5% of lenders who lend across 100 loans for a year have earned less than 4% interest.

I have just run our most conservative stress tests on these three borrower grades – the tests we use to award PLUS Ratings and Risk Scores. The results show that during a severe recession, I would expect some people to make short-term losses, but it will be a rare lender who makes a permanent loss.

Your bad debts won't necessarily decline much further and they might also recover. It can take a few years, but Funding Circle has so far recovered over 40% of bad debts. That's a pretty good result for this kind of lending. If your luck turns and you make average recoveries, this will greatly boost your overall returns.

In the meantime, you will continue to earn interest every year on your good loans. Re-lending that interest – either through Funding Circle or elsewhere – will help to ensure that your returns stay positive across your whole lending portfolio.

Watch the interest rates. Funding Circle has recently lowered interest rates in its top grades and rates have been gradually falling. Whenever lending interest rates go down, it doesn't just lower your returns but increases the risk that you will lose money overall.

While the decreases at Funding Circle are fairly significant, our stress tests indicate they are still sufficient for the risks involved. But it's something to keep an eye on.

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