2016: the year we built on the foundations
It’s that time of the year, where tradition expects we review the previous 12 months, typing out our thoughts as mince pie crumbs scatter the keyboard. It was ever thus, with annual reviews probably going back to cuneiform script on clay tablets.
It’s been quite a year, but by that I don’t mean Trump, Brexit or any of the other political upsets that are in danger of becoming commonplace. Unless the new president-elect attempts to crowdfund his proposed infrastructure projects through UK P2P, this isn’t our bailiwick (though, let’s face it, if this year has demonstrated one thing, it’s that anything is possible). Instead, this yuletide review will highlight ThinCats’ development over the past year.
We’ve spent considerable resources over the past year developing the foundations for the future. Most of this has been focused on supporting lenders, examples being: bringing loan monitoring in house, the creation of a Credit team, Credit and Security gradings, building a Recoveries team, and the extensive expansion of our IT capability, particularly bringing this entire function in-house.
Here is a summary of some of the developments over the past 12 months:
- We have brought loan monitoring in-house (see ‘Upping loan monitoring resources’, below). This was previously the responsibility of our Sponsors, but we recognise that there is a natural division of labour, with the Sponsors being focused on the borrower, while ThinCats overarching duty is to our lenders.
- We have built up a skilled and detail-focused Credit team. All of the loans on the platform are now scrutinised by this team before listing. Loan transparency is further improved by the addition of our five-star Credit Grading and five-padlock Security Grading, which we introduced for all loans on the Primary Market over the summer.
- IT has been a priority, and we have improved systems and security, bringing the function in-house, with a significantly expanded team (see the technology review, below).
- In order to facilitate a strong and diversified pipeline of loans, we have created an Origination team under Damon Walford. Each member of the (still growing) team is regionally focused, building relationships with brokers and other financial professionals who help SMEs raise loan capital.
- The creation of an in-house Sponsor function through ESF Capital. This is to support financial intermediaries new to ThinCats, or who do not wish to take on the full responsibility of a Sponsor, thus further developing the loan pipeline.
Over the past 12 months, we have spent energy and money to create an infrastructure that we believe can take ThinCats forward as a world-class P2P business. It is now able to accommodate considerably more loans and lenders, in a way that we hope all clients can have confidence in.
Diamonds are for… five years and very well secured
Diamonds are a peer-to-peer lenders’ best friend, as Shirley Bassey sang. Or meant to, we’re sure. Cardiff’s finest export will doubtless have had many a diamond stocking filler at this time of year.
ThinCats has also had a thing or two to do with diamonds, with the platform’s recent exposure brought to a successful conclusion through a repayment of £3.9m by Diamond Manufacturers, which has been a borrower on the platform since 2013. However, this history helped the platform keep its exposure to the hardest substance known to man.
Henig Diamonds Parcel (HD) is a Hatton Garden-based diamond merchant, which has been trading for more than two decades.
Ivor Freedman, senior partner at sponsor for the deal, Freedman & Partners, said: “We knew the people at HD, and the fact that ThinCats had already leant to the diamond industry was a way of raising the prospect of doing business with them. Three months after we spoke, the firm contacted us about taking out a loan on the platform.”
HD is a profitable business with a turnover of £7.5m a year. “What’s clever about HD is its software interface, which allows the client to see exactly what they get,” added Freedman: “It is underpinned by a business model based on service. This is a great example of how ThinCats capital is helping to expand an already successful business.
HD raised £700,000 through ThinCats last month, repayable over five years at a rate of 9%. The loan was to buy diamonds for resale, with the 50% loan-to-value security being HD’s diamond stock.
“The loan is taking over from a facility from Barclays,” explained Freedman. “While the latter is cheaper, it’s over a shorter period – 170 days – and HD required a longer period to ensure they could sell the stock.”
The deal gives lenders a high level of transparency – and not just because of the clarity of the stones.
HD will ensure that it has at least double the value of the amount borrowed in the form of diamond stock, to be topped up at every month end. It will provide quarterly and annual accounts, and there is provision for ThinCats to carry out a stock audit by a third party upon request.
Underpinning the security in diamonds of £1.4m is its stock of about £4m, along with £5m of stones permanently on consignment from one of their suppliers. The three-star graded loan is underpinned by a four-padlock security grading.
ThinCats head of credit, Simon Brook, commented: “We were pleased that covenants give us considerable visibility over the security. The regular reporting and the bankable nature of the collateral gives us confidence.”
Rate trends in a maturing P2P market
From our analysis of the market we anticipate lower average loan rates, along with an increase in loan quality.
These linked trends are a confluence of events in the wider alternative finance SME loan market – indeed, debt markets generally – and ThinCats’ own due diligence.
The new ‘new normal’
This isn’t a new trend in alternative finance, but it is feeding through. Private debt market yields have been slowly declining from their peaks at around 2010 or ’11. The dynamic isn’t difficult to understand: prior to the global financial crisis, European banks, including those in the UK, dominated business lending, with about 90% market share. In the credit crunch that accompanied the crisis, banks stopped lending. Companies still needed cash, and so while demand stayed strong, supply had collapsed. Enterprising investors, from private debt funds to ourselves, noticed this gap and entered the market.
It was initially like filling a bath with a thimble. However, rates came down earlier in some areas of the market, particularly with larger and more ‘plain vanilla’ loans, as banks, having detoxified their back books, decided they would come back into the game – albeit on a much more limited basis than previously.
We have been deliberately lending in an area of the market that is less attractive to the increasingly box-ticking driven approach of the banks. However, we are not immune to the general trend, and competition is increasing, so depressing rates.
One further factor should lower average rates on the ThinCats platform over time, and that is the overall quality of deals that we attract. Our Credit Team has been carrying out due diligence on loans for about a year, and believe that this adds an important layer of security for our lenders. We put considerable resource into determining a company’s ability to service its debts – something that had historically been the responsibility of the Sponsors. Credit markets being (relatively) efficient, one would expect this to positively affect the default rate, thus helping shield lenders from loses that an absence of checks could bring.
The corollary of this is that higher quality loans be less risky and so pay lower rates. Higher risk correlates to higher rates, which is what you might see in, for instance, credit markets: high-yield bonds pay a higher coupon than investment grade bonds because of the higher implied risk; investment grade bonds pay higher rates than government for the same reason.
So, while the enhanced returns generated by extraordinary market conditions look like they are tapering out, the positive news is that quality control operated by ThinCats should facilitate more stable returns to our lenders, provided by transparently-priced quality loans.
Investing in Technology – Review of 2016
By Steve Thomson, Chief Technology Officer
The past year has seen a step change in how ThinCats technology operates. Over the past 12 months we have put in a series of changes that start the journey to make ThinCats more efficient and secure, and lay the foundations for the further development of the platform. Below, we explain the most significant.
Technology moves under our control
Historically, our technology was developed and supported by a separate company owned by one of the founding shareholders. We agreed at end of 2015 to transfer full control of technology to ThinCats by the end of 2016. During the year:
- July – application hosting transferred to us and client data was relocated from Ireland to the UK;
- September – responsibility for all production support transferred to us;
- 1 December – we assumed full control of all of our Technology including application development
This means that we are, as of now, firmly in the driving seat and can develop the platform solely for the benefit of ThinCats clients, reducing external operating costs, thus freeing up investment to make technology improvements more quickly.
The in-house Technology team has grown from three to nine over the course of the year. However, we continue to operate very efficiently compared to a number of our competitors.
Client money reconciliation is now fully automated
ThinCats has a responsibility to clients to ensure that client money (that is, our overall cash liabilities to clients) is appropriately segregated and controlled under the FCA’s CASS regime. This means reconciling client money balances and calculating the overall client money requirement every business day for submission to the FCA.
As ThinCats has grown, the task of client money management was becoming increasingly inefficient. In July, we therefore decided to fully automate client money reconciliation, and so partnered with an industry-leading provider of institutional-class reconciliation software, Watson Wheatley, to undertake this. This work has now completed with automated links between the ThinCats client system, our payment processor Street UK and Barclays Bank.
Ongoing programme of Technology security enhancements
The threat of cybercrime is ever-increasing and at ThinCats we take our responsibilities very seriously. As such, we have had an ongoing programme of system and infrastructure improvements throughout 2016 to address evolving security threats.
As part of that programme, we carried out a full external vulnerability assessment in Spring 2016 and since then have been working to reinforce our security policies and technology with our security partners ZeroDayLab and SecurityAlliance. We will carry out another external vulnerability assessment by the end of this year and will do that regularly going forwards. In 2017 we expect to roll-out enhanced security user login procedures.
ThinCats office infrastructure
In October, we rolled out new technology infrastructure in our Ashby office to support the growth of the business. ThinCats now has an office infrastructure to the same institutional standard as our majority shareholder, ESF Capital, including high-speed networking and video-conference facilities. We will also shortly be introducing Voice Over IP telephony to the office.
Finally, we have implemented a full Business Continuity/Disaster Recovery environment. We will be conducting a full formal test of this early in 2017
Coming up in 2017
We recognise that much of the work done in 2016 has not been directly visible to clients. However, it underpins important Regulatory requirements, security, reliability and enablers of future functionality. We now have established a firm foundation to take the business forward in 2017.
First up is to address a number of long-running system performance issues which are very high on our clients list of concerns – this includes unacceptably slow dashboard load times, slow primary and secondary market load times and delays in confirmation of bids, particularly during popular auctions. We expect to make significant improvements to performance by the end of March 2017.
Street-wise: explaining our direct debit and defaults process
Lenders’ funds are completely segregated from those of ThinCats through the company that provides our payment processing facilities, Street UK (Street). This is an important and necessary control, and determines not only the security of your money, but also when you are paid the return on your loan and is bound up with what happens if payment is missed.
Street collects payments from borrowers’ accounts via direct debit. This means that a fixed repayment date can be scheduled in accordance with the payment schedule as defined in the loan agreement. If a payment due date falls at a weekend or on a bank holiday, under the service agreement, Street will debit borrowers accounts the first working day after the due date, but not before.
Once payments have cleared successfully (next working day following collection date), ThinCats lenders’ accounts are credited within two working days.
In the event of Street being unable to collect payment via direct debit, the company advises ThinCats of the failed repayment. As a precaution, we change the secondary market status of the loan in question at this point. In the event of a banking error, these are generally able to be rectified within three working days and Street processes another payment by direct debit, which is received at the earliest by day four following the original payment date.
Where a direct debit fails for the first time and there is no known reason, we will work with the Sponsor and the Monitoring team to ascertain the reason. In these circumstances, the payments are not usually deemed to be in default until the fifth day following the first failed direct debit; the failure of subsequent direct debits is considered an immediate default.
If payment of the first failed direct debit is not received by the fifth day following the scheduled payment date, a syndicate update is issued. In the event of a payment default, the secondary market status is not updated back to status ‘A’ until all arrears including accrued interest have been paid and at least three consecutive direct debits have been collected successfully, and on the due date.
Should lenders have queries relating to missing payments, these should be raised directly to ThinCats Admin Team.
Upping loan monitoring resources
ThinCats has recruited an in-house loan monitoring manager, Melanie Lee.
Mel will undertake the quarterly monitoring of all new loans, as well as test the monitoring of the historic loan portfolio by the Sponsors, under the terms of the current Sponsor Agreements. Discussions are in progress with Sponsors to transfer the monitoring of the historic loan book, although this will take some time to complete.
Where we are no longer working with a Sponsor, the monitoring of all loans from that Sponsor has been transferred to ThinCats with immediate effect.
As part of the monitoring, borrowers will be required to submit the following information as a minimum:
- Management accounts (including Balance Sheet, P&L and comparison with budget)
- Up to date aged debtors and aged creditors listings
- Confirmation that VAT are PAYE are up to date (with supporting documentation)
- Certificate of Compliance with Financial Covenants and supporting computations
- General trading update on how the business is doing
The financial information will be reviewed and any issues or adverse trends will be discussed with the borrower. Financial covenants will be tested by ThinCats.
All loans are tracked via an external risk analysis system, which provides daily credit and business information, and further drives the monitoring process.
Mel will liaise closely with the Recoveries team, which will provide assistance to the borrower to resolve issues. This can include negotiating variations to the loan agreement or taking enforcement action in the event of default.