Using the new loan gradings: Balancing risk and reward Should you invest in a loan that isn’t four or five star? Five star loans aren’t ‘good’ and one stars ‘bad’, any more than AAA-rated corporate bonds (of which there are vanishingly few these days) are good, and high-yield bonds bad.
ThinCats newsletter November 2016
Introducing new introducers
A core goal for ThinCats is to increase the volume and range of deals available to lenders on the platform. As all our loans are introduced through Sponsors and other business professionals, it’s vital that we develop our relationships with those best able to provide the lifeblood for SME P2P lending.
We have allocated considerable resource to this, and are delighted to see that it is beginning to bear fruit. Loans from new sources are beginning to appear on the platform. One example being the recent Shiny Sky loan (trading as Arrow Cars), brought to our sponsor ESF Capital, by introducer SME Capital.
Arrow, founded in 2004, is the second largest private hire company in Leeds and, through a process of bolt-on acquisition, is making its mark nationally. It is, for example, the largest specialist airport operator in the UK. The taxi company has grown by focusing on the provincial areas around its established bases where there is less competition. The firm has contracts with four major airports, providing 49% of revenue, as well as a number of corporate accounts with local universities, councils, professional services, and hotels. Alongside Leeds, it has operations in Manchester, the East Midlands and Bristol.
The company was looking to raise £1.25m for an acquisition that would raise the size of its fleet from 500 to 660, and had been working with SME Capital to source the funding.
Antoine Grisay, chief executive of SME Capital, said: “The deal was a straight forward credit story, and the company wanted to deal with someone who could make a rapid underwriting decision. The process went very smoothly – the deal was structured rapidly, and was executed in just a few weeks.”
The loan was listed at 8% and security included first ranking debenture over the assets and a share pledge.
 Source: ThinCats’ Information Pack, 9 September 2016.
Signs of success in 2016
Chinese premier and history buff Zhou Enlai was once asked what he thought the legacy of the French Revolution was. Zhou pondered before answering that it was “too early to say”.
Although it is early days since ThinCats implemented credit screening at the beginning of the year, it may not be too early to judge it a success.
Of the £55.4m lent so far this year, 0.87% has fallen into default and we forecast this will be 0.26% post recovery. And we are still fighting to recover as much as we can.
ThinCats had been building up resources over the latter part of last year, and has been increasing the emphasis we place on this process throughout the year. This is a new area for the business, but we are using tried and tested methods with a highly-experienced team head, Simon Brook.
Brook explains: “It’s important that lenders still do their own research into loans on the platform. However, we want insure that a base level is achieved, where our team of credit experts have reviewed all loans, rejected those we thought unsuitable, and sought clarification with the Sponsor and borrower where needed before they are listed.”
Some of those loans listed on the platform before credit screening will not be of the same quality as those listed now, though this will increasingly become the tail of our loan book over time, and eventually disappear.
Disclaimer: Past performance is not an indicator to future results
Using ThinCats’ gradings
You want to go to cinema, but what to see? Easy – just pick the film with the highest rating. Five stars and you’re front and centre, with super large bucket of popcorn.
Western, scifi, romcom, action – doesn’t matter, just so long as it’s got the most stars.
No-one chooses a film like this, so why would you chose an investment on the same basis?
The above point is made to highlight a danger of total reliance on ThinCats’ star and padlock gradings, for credit and security quality respectively. We’ve put a lot of work into developing these, and we believe they are strongly predictive of outcomes in their respective areas. However, they are not a substitute for lenders’ own research, using the investment packs and other materials. They supplement this research.
For instance, a five-star loan is not ‘better’ than a four-star one. Our analysis, based on multiple quantitative metrics, shows the former to be a lower-risk one. Both should be priced accordingly. In the same way, an investment-grade bond is not better than a high-yield one; blue chip equity is not better than shares in small cap companies. It all depends on your risk tolerance and your investment objectives.
Crucially, it also depends on how a loan fits into your broader portfolio. Lenders should always be looking to build a diversified portfolio in order to arrive at a level of risk with which they are comfortable. It’s therefore inadvisable to invest in a loan just because it is underwritten – or on the basis if the institutions like a loan, then it must be good. An underwriter has its own clearly-determined investment strategy and portfolio guidelines. So if an institution invests in a loan, it will likely compliment or advance that strategy. However, that same loan, added to another very different individual portfolio, may adversely change the risk-reward trade-off of that portfolio.
Gradings are important and useful tools for the investor. But they are best used as a way of informing broader investment research. Your initial screening should not be your only screening.
Loan monitoring comes in-house
ThinCats has established a dedicated team to monitor the status of loans.
Historically, loan monitoring was the responsibility of Sponsors. However, we recognise that they of necessity have a greater focus on borrowers, and this was very much a lender-orientated service. As in other areas, we have therefore established a clear division of labour: one which we believe will work in the interests of lender and borrower alike.
The listing and monitoring of a loan, pre- and post-drawdown, is now as follows:
- Sponsor submits all loan proposal documents to the Credit Team
- Loan & Security grading provided and included in documentation
- Credit Team reviews loan to be listed. Three options are available:
- Request further information, or changes to terms
- Listing Team list loan on Platform
- Details are added to the Secondary Market Spreadsheet (SM), including an estimated drawdown date. This is visible to lenders
- Should drawdown not happen when anticipated, the Listing Team will contact Sponsor for an update. The Sponsor’s response is then added to the SM spreadsheet to keep lenders advised
- Sponsors may comment in loan Q&As about delayed drawdown, providing further details for lenders
Borrowers are provided with a document timetable that details information required and due dates for its receipt.
Reporting and payment dates for each borrower are established.
- Financial information received from borrowers is reviewed and a trading update obtained. With each quarterly submission borrowers provide a Certificate of Compliance with the financial covenants set out in the loan agreement. Covenants are checked in-house.
- Late submission of information will be followed up by the Monitoring Manager. Contact will be directly with the borrower, with the Sponsor advised of any delays.
- All loans are tracked using an external risk analysis system, providing timely credit and business information, which further drives the monitoring process.
- If there is adverse information, either from the external risk system or as a result of the monitoring checks, the Monitoring Manager will liaise closely with the Recoveries Manager, who will provide assistance to the borrower to resolve issues. This could be negotiating changes to the loan agreement or taking enforcement action in the event of insolvency proceedings.
- The status of loans is updated on the Secondary Market list in response to any adverse information or default, or if there is a possibility of the loan being repaid early. ThinCats will then prevent the sale of those loans on the Secondary Market.
Where we are with our FCA application
ThinCats submitted its application for full authorisation in by the deadline in October last year. We are presently working with the Financial Conduct Authority to help the regulator understand us and the sector. ThinCats, like the other large members of the P2PFA, has yet to receive authorisation.
All P2P platforms have interim FCA permission. We submitted our full application for authorisation by the required deadline of 31 October 2015 and we continue to work with the FCA in answering its queries and accommodating its site visits. As the regulator has said, full authorisation may take up to 12 months: however, this not from the date of application, but from the date that the last substantial queries were raised.
None of the main P2P platforms have received full FCA authorisation to date, to the best of our knowledge. UK Bond Network, which has, offers investment bonds and are not a true P2P platform operating under article 36H.
The FCA issued a Call for Input over the summer, where it issued questionnaires to about 30 platforms. It has visited seven of them to undertake site visits over several days. As one of the larger P2P platforms, the FCA chose to visit ThinCats. The purpose of the questionnaire and the visit was to enable the FCA to obtain a better understanding of the business models operated by the various platforms.
We can assure you that we are doing everything in our power to progress our application as expediently as possible, and will keep you informed of our progress when we are able.