Following the news it is quite obvious a slowdown of the world economy is ongoing. It may turn out to be a recession in the Euro area.
So how will P2P lending be impacted by a recession?
At the last recession, the financial crisis 2007-2008, P2P lending was rather new. Lending Club in the US was fully operational and it is interesting to study the yield that Lending Club investors got during the financial crisis. As can be seen in the table, it was positive although not very high. Effectively this means credit losses were limited and covered by the interest payments.
We can also study the yield on credit card loans during recession. During the last recession, the default rate for credit card debt increased from 4% to 11% but this was still well below the 14% average interest.
The conclusion from studing the last recession is that consumer credit is fairly robust. That said, the next recession may be more severe and I will now examine a few strategies for minimizing the risk.
To protect investment and minimize risks, it is wise to monitor unemployment closely. Rising unemployment is the canary in the mine, rising private credit defaults will follow. For P2P investors, credit losses will rise. The connection is the obvious one, unemployed people can often not pay their interest.
If the unemployment rate is rising, one defensive strategy is to shift from higher yield and lower credit rating to lower yield and higher credit rating. Higher credit ratings are far less likely to default, this is true for all market conditions.
If recession is putting pressure on the P2P industry, the risk of platform default will increase. One defence for this is to diversify the portfolio. This is something I am currently doing as a preventive measure. I am currently investing in 12 different platforms.
Different countries may get hit more severely, it could be a wise strategy to reduce exposure to the countries where the unemployment rises fast.
To predict the future is not possible but judging from the past I think the P2P industry as a whole is quite robust.
Almost every review of a peer-to-peer site or offering focus on the existance of buyback and the detailed terms. More seldom is the question asked:
Is buyback really worth the associated cost?
The obvious risk when buying a P2P loan is that the borrower can’t pay his interest. Eventually the loan will default, usually after 60 days. Then, normally, the buyback guarantee kicks in and pays the investor the principal value or part of the principal value, sometimes even interest.
How much does this guarantee cost? It depends of course, but generally the P2P loan investments with buyback yield around 12% currently (Mintos, Twino, Fast Invest). The corresponding figure without buyback is maybe around 19% after credit losses (Finbee, Neo Finance). The comparison is complicated by the fact that there are other differences between these offerings. But it is astonishing that buyback has become so popular when it is so expensive in terms of lost yield. So what is it that investors try to insure themselves against that makes it worth the cost? Here are the reasons I could think of, there may be more:
Defaults could rise if the economy deteriorates, especially if the unemployment rises. There is a very strong correlation between unemployment and personal loan default rate. My view on this is that buyback is a good insurance in this case up to a point where the loan providers get in financial trouble from absorbing all the defaults or alternatively the buy-back-fund is empty. Then the buyback guarantee becomes useless.
It is as far as I know impossible to make a tax deduction for non-performing loans until collection is complete, so there may be a tax penalty for having a large stock on defaulted loans. In my model it makes a quite small difference if the collection is completed within a year compared to selling the loan (for the collection percentage). I will not go into the details in this post.
There are sometimes no or limited possibilities to sell defaulted loans so there may be a long lock-up time for funds for the investor.
The investment becomes more predictable, thus planning investments ahead becomes easier.
My personal take from this is that it makes sense to diversify. A portion of the portfolio can be more locked up, without buyback, giving higher yield. Another portion can be protected by buyback, being more accessible.
In case of a severe economic downturn, the question is what level of defaults the loan originators can manage and still maintain the buyback guarantee. It can be attractive to reduce exposure to buyback in such a case, especially loan originators with mainly low grade loans (C, D). As an alternative high grade (A+, A, B) loans without buyback could be considered.
Update 14 aug: It seems the payments from Aforti will recommence. The message is technical problems are the root cause for the disruption. Given that also other platforms than Mintos have experienced problems with Aforti it is likely in the Aforti system.
Looking at Mintos Loans in Roubles, it is immediately clear there are nice interest rates. Examples:
EcoFinance (rating B), 19.5%, 60 days term
Kviku (rating B), 19.1%, 12 months term
Dozarplati (rating B-), 19.0%, 12 months term
Mikro Kapital (rating A-), 18.0%, 24 months
It is quite feasible to get an average interest rate around 19% from this, which can be compared to what is currently possible in Euro loans, which is around 15.5%. So currently the difference is 3.5% in favor of Rouble loans.
Is this a good compensation for taking on the currency risk?
Behold the high mountains and low valleys of the Rouble to Euro exchange rate:
My purpose writing on this website is to share experience from P2P investments, news from the P2P community, thoughts and comments on the market development. It is a fast growing, fascinating field and I really look forward to documenting it here.