ThinCats newsletter September 2016 26/09/2016
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. It really all depends on what you are looking for.
A loan with fewer stars will carry greater risk, but it should also offer a better return for that level of risk. You can read more details on the grading system here.
August’s loan to West Midlands-based heating, ventilation and air-conditioning contractor MVS is one of the first on the platform to receive a grading: three-stars for credit and three padlocks for security. It continues the trend in quality, larger deals on ThinCats, and has been fully underwritten.
Credit grading is an automated process, drawing on a wide span of data, so there will always be multiple causes for a single result. For instance, on the one hand, the business is well-established, profitable and cash generative, with no debt prior to acquisition. Its order book underpins the forecast levels of turnover. On the other, it has a significant portion of its business concentrated on just two customers. And there are many, many other factors feeding into the grading system to produce one metric.
A three-star credit rating denotes medium risk. It’s worth noting that the progression from low to high-risk isn’t linear – the insolvency schedule steepens as risk increases. And, of course, the insolvency rate changes with economic conditions – as they worsen, the line will move up and steepen. Our analysis shows it steepens more at the highest risk portion.
MVS borrower Andrew Dowd has raised a two-tranche £1.25m term loan through ThinCats for a management buy-in: one tranche amortised over five years, and the other an interest-only, bullet repayment.
Both tranches are 10%, and rank equally.
ThinCats credit analyst Cory Elley said: “Low leverage and a solid pipeline of quality, secured contracts made this an attractive deal for ThinCats and, we hope, our lenders.”
Security is in the form of first-ranking debenture and share pledge. Specific underwriting performance covenants should also protect lenders, including that the value of secured but un-invoiced contracts be at least £2m, and that gross debt to EBITDA be less that 1.5-times.
Working more closely with Sponsors, to further help lenders
As part of our ongoing improvements in the service to our lenders, ThinCats is becoming more closely involved with the work of our Sponsors. We are increasing the support and monitoring of their work, from loan origination to the final payment.
Head of Risk & Recoveries, Jill Sandford, said: “Investment in ThinCats over the course of the year has allowed an increased and mutually beneficial division of labour to develop between the ThinCats platform and our Sponsors.”
“Sponsors are able to focus on loan origination, working with prospective borrowers to structure loans for the platform, while ThinCats is able to focus on representing the interest of the lenders.”
Over the past few months, this investment has led to the creation and development of Credit and Recoveries teams, and so the capacity to objectively review the quality of our Sponsors. It has also increased the due diligence conducted in the areas of credit quality, underlying security, ongoing loan monitoring and IT infrastructure.
ThinCats will consider removing a Sponsor if loans are of not high enough quality; if the Sponsor fails to carry out adequate monitoring of the loans, or otherwise not perform the function of Sponsor in a way that we deem professional enough. On this basis, after careful consideration and on the basis of these criteria, we have decided to stop working with two Sponsors.
We will take such actions in support of our lenders, in order to protect the quality of loans on the platform and represent lenders’ interests during loan monitoring.
Recruiting more Sponsors
ThinCats is continually looking to build relationships with potential new Sponsors.
As with monitoring loan and Sponsor quality, this is a capacity that has been enabled through investment over the year. Our origination team, led by Ravi Gidoomal, is building introducer relationships with commercial finance brokers, corporate finance firms and other professional intermediaries, in order to create a scalable, repeatable pipeline of loans onto the platform. Again, the focus is on quality.
We are working with introducers, supported by our in-house Credit team, in order to develop the best of these into full Sponsors.
Expect to see new loans from new sources in the future.
Don’t have your ThinCats portfolio marching in lockstep
The Albert Bridge, a wonderful Victorian structure, spans the Thames between the London boroughs of Chelsea and Battersea. As you go across it, a sign warns to “break step when marching over this bridge”. That’s because troops marching in lockstep would create synchronised shocks that could send the bridge rocking alarmingly.
It’s very much the same case with investments: you don’t want your portfolio marching in lockstep.
We want to ensure that our lenders have as good a selection of loans available as possible, not simply because having more choice is a good thing in itself, but because a well-diversified portfolio is a less risky one. Not having all your eggs in one basket may be a hoary old nostrum, but it is also a tenet of investment theory and practice that has proven its worth since the Dutch discovered that counting your wealth solely in terms of tulip bulbs was a really bad idea.
It’s not simply the number of loans you have in your portfolio, but how different they are.
So, for example, holding five loans, each from an engineering company, a travel firm, a windfarm, a construction firm and a brewery will almost certainly give you better diversification than holding a portfolio of 10 loans, five of which are windfarms and the others construction.
This is because what determines the performance of each of the five companies in the first portfolio is probably very different: customers, costs and stresses on a brewer are not the same as for a windfarm, and so on down the list. Ten loans from just two industries may give you exposure to just two different markets – one, even, if the industries are interlinked closely.
While it’s natural for lenders to have favoured sectors – perhaps because of a specific area of expertise they have – they should also be aware that any strong bias to a single sector in the portfolio increases the overall risk, and so the potential for loss.
You can diversify not only through industry, but by region: a construction firm building in Gloucestershire may well be working in a market different in many ways to a construction firm based in London.
ThinCats spread of loans per industry (Jan 2011 – June 2016)
ThinCats endeavours to bring you as broad a range of loans as we can, and to provide you with all the information you need to make the selection most suitable for you. That’s why we introduced our two-fold loan grading system earlier this month, with Stars denoting credit quality and Padlocks the level of security. Diversification by risk is very different to diversification by sector or geography, but these gradings do give you a further insight into how your portfolio may be structured – whether you have more higher-risk loans than you may be comfortable, or could possibly take on more risk for more potential return. It should also allow you to see if higher risk loans are concentrate in a particular area, which you may want to address, or if they’re reasonably well distributed throughout your portfolio.
Introducing the introducers: ESF’s Sponsor role
In our drive to increase the number of Sponsors – and so deals – on the platform, we are working with a growing number of business professionals.
These professionals are generating loans from their SME clients for listing on ThinCats. They are not accredited Sponsors at this stage, and that role is being fulfilled by ThinCats’ owner ESF Capital.
This raises questions of who does what, who is acting on behalf of whom, and how this situation will develop.
ThinCats acts on behalf of the lender, and this will continue to be the case. ESF takes on the responsibility of Sponsor: completing the documentation and procedures necessary for listing, taking on responsibility for answering lenders’ questions, and of post-drawdown reporting.
This has been structured in such a way as to avoid any conflicts of interest: the team monitoring the loan on behalf of lenders at ThinCats is organisationally distinct from that of the ESF team structuring the deal pre-drawdown and working with the borrower post drawdown. Indeed, the teams are even geographically separate, with ThinCats in Ashby and ESF in London.
One recent example is the Robert Goddard Ltd loan, introduced by Pilot Fish and Sponsored by ESF. As with any other Sponsor, ESF is ultimately responsible for responding to lenders’ question on the loan, plus other Sponsor reporting duties. This information is gathered from both the company and the introducer, Pilot Fish.
When we have developed a relationship with the introducer such that we are confident in their ability to undertake the role of Sponsor, they may undertake that role in full. Until that is the case, ESF will support the introducer to ensure that lenders receive the full service that we require from our Sponsors.
In some case, business introducers may be happier with this less integral relationship, in which case ESF will continue to provide the role of Sponsor for loans they introduce.
The purpose of this is to bring new Sponsors onto the platform, and so increase the number and variety of loans available to our lenders, while offering the best quality of due diligence and service.
New additions to the ThinCats team
Damon Walford – Chief Development Officer
Damon has over 25 years’ experience in financial services, predominately in the SME banking sector working for both HSBC and RBS. He has overall responsibility for developing the ThinCats business.
Damon joined ThinCats in July 2016, having spent 12 months running his own Fintech consultancy business and researching the market. Prior to this, he was Managing Director of Aldermore Invoice Finance, where he helped take the business through a successful IPO in March 2015.
Mike Millington – Partnership Manager
Mike has joined ThinCats as the newly-created role of Partnership Manager. His role is to support our growing number of Sponsors and Introducers when listing new loan opportunities to ensure we bring in quality cases to the Platform as smoothly as possible, ensuring that the information packs are robust in all cases thereby providing investors with comprehensive details regarding each loan. Mike has spent 28 years with NatWest/RBS, latterly as Finance Relationship Director. He has managed a wide variety of clients, from small SMEs to large corporate entities, working on both trading businesses and property development.
Vik Lad – Customer Services Manager
Vik has spent more than a decade in regional branch management at Santander, where he was responsible for a client-facing role dealing with operational matters regarding client funds.
In this new role at ThinCats, his responsibility is to use this client experience to work with the team to develop our lender communications and provide an exceptional customer experience.
ThinCats has moved
Just a reminder that we have moved to new premises. Our new number is 01530 416123, and the address is 2 & 3 Charter Point Way, Ashby Park, Ashby de la Zouch, Leicestershire, LE65 1NF. All other details remain the same.
The move was necessary to support ThinCats’ expanding business, necessary to support our drive for a more efficient lender-centred platform. Since the end of last year, our headcount has almost doubled, with further expansion planned.
Of base rates and P2P loan rates
In August, the Bank of England Monetary Policy Committee dropped the UK base rate to a historic low of 0.25%. 10-year gilts now yield about 0.5% – again, another historic low.
In a world demanding income, we believe conventional income-bearing assets will disappoint for some time to come, but secured SME loans will continue to pay investors a significantly higher return, depending on the portfolio you build for yourself and the losses you incur. Read more about default rates.