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Post by buggerthebanks on Jan 18, 2015 12:12:23 GMT
I've had an awful lot of loans repaid early over the last few months (2, maybe 3 p/week), too many (I feel) for a relatively modest holding. I'd love to know if these are genuine repayments by lenders or the Provision Fund back-stopping defaults.
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duck
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Post by duck on Jan 18, 2015 14:46:36 GMT
I've had an awful lot of loans repaid early over the last few months (2, maybe 3 p/week), too many (I feel) for a relatively modest holding. I'd love to know if these are genuine repayments by lenders or the Provision Fund back-stopping defaults. I'm surprised at your figures, a quick check of my spreadsheet shows 384 current loans with 5 'repaid' this month, 4 in December and 6 in November.
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webwiz
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Post by webwiz on Jan 18, 2015 15:53:10 GMT
Of course, in principle, the bigger the PF the better. However remember that this is money which could have been paid to lenders in higher rates. So in a sense the PF is lenders' money which is being held back to cover future defaults. It is similar to a With Profits Endowment Policy where not all of each year's earnings are added to the fund, some are retained so that in bad investment years the return can be topped up. The problem with both is that investors in "good" period subsidise other investors in a "bad" era.
But there is an alternative. Instead of having a PF, which will always be either insufficient to meet losses or will be over provided at a cost to lenders, have a system whereby on each and every loss due to default a surcharge is made to each and every lender on a proportionate basis. this is similar to the FSCS funding model. Such a system could not be used on platforms where lenders choose their loans on a risk/reward assessment but I don't see why it could not be used on RS and Zopa. Those who invest and cash in during a "good" time will be better off and vice versa, which seems fair to me.
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c88dnf
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Post by c88dnf on Jan 18, 2015 18:12:24 GMT
In principle the bigger the PF the better. Instead of having a PF, which will always be either insufficient to meet losses or will be over provided at a cost to lenders I disagree. The size of the PF is not a direct indication of its robustness. The key determinant is the quality of risk assessment in respect of defaults. The better that quality, the smaller the fund can be. Similarly the comment about "always.... insufficient" is inaccurate. The fund's size is determined by the estimated risk of defaults happening simultaneously. You either trust those estimates or not. If not, the only place to invest is in HM Govt bonds and even then you're banking on the government having sufficient liquidity to pay 100% defaults occurring simultaneously. Government of Iceland anyone? On cost to lenders, since last year there isn't any (at least in a direct sense). Borrowers provide the funds.
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webwiz
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Post by webwiz on Jan 19, 2015 8:12:49 GMT
It is simple logic that a PF will be either too big or too small. If it's too small then it won't be able to cover all the losses and if it is too big then money is being wasted as far as the current participants are concerned (borrowers or lenders or both) and will subsidise a future tranche of participants.
The point I am trying to make is that there is a cost to having a PF. It's like an insurance policy, if you are over insured you are wasting part of the premium. So lenders should logically want the platform to get the PF to as close to the optimum as possible, not simply as big as possible.
Or do away with the PF and change to a surcharge system as I described. The PF is largely an illusion, a comfort blanket. Effectively the losses which are likely to caused by defaults are subtracted from lenders' income (or added to borrowers' costs, or both) in advance. It's just a great marketing tool, which is why they won't change it.
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Post by davee39 on Jan 19, 2015 9:03:58 GMT
It is simple logic that a PF will be either too big or too small. If it's too small then it won't be able to cover all the losses and if it is too big then money is being wasted as far as the current participants are concerned (borrowers or lenders or both) and will subsidise a future tranche of participants. The point I am trying to make is that there is a cost to having a PF. It's like an insurance policy, if you are over insured you are wasting part of the premium. So lenders should logically want the platform to get the PF to as close to the optimum as possible, not simply as big as possible. Or do away with the PF and change to a surcharge system as I described. The PF is largely an illusion, a comfort blanket. Effectively the losses which are likely to caused by defaults are subtracted from lenders' income (or added to borrowers' costs, or both) in advance. It's just a great marketing tool, which is why they won't change it. The provision fund makes visible something that Banks normally hide. Rates from Banks have always varied according to risk. Ratesetter uses this variation to produce a 'matching rate' to allow borrowers to match with lenders, and a risk based surcharge which goes to the provision fund. In a highly competitive market any reduction in provision fund contribution does NOT lead to higher lender rates, but to lower borrower fees, allowing more borrowers to be attracted. While the fund is an excellent marketing tool (so good it has been copied elsewhere) it is also an integral feature of how the platform works. Once ISA inclusion is introduced the fund will be an essential tool in attracting money from low rate FSCS protected accounts. The recent historic £11m weekly lending record will be blown away in the stampede.
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jlend
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Post by jlend on Jan 19, 2015 10:06:46 GMT
Part of me regrets the prudent methodology we have chosen to implement, as in some cases the coverage ratio is forced to drop every time we complete a loan. The expected losses calculation uses nearly the peak month of defaults (12months extrapolated to 60months, with peak default at 9months, so takes no advantage from the flattening curve as older loans don't typically default as they approach term), and so the coverage is dropping with every new loan but increasing as the more nature portfolio is cleaned and doesn't call of the Provision Fund. Due to the high level of recent lending, this seesaw has seen the coverage rate decrease. I'm relaxed about the size (£10m) and strength of the Provision Fund in comparison to the balances covered and quality of portfolio, however I do recognise that the drop in coverage could be disconcerting. Part of me thinks we should not have been so overly prudent, and we are shooting ourselves in the foot from a Marketing brand perspective. However it would be wrong to change this overly prudent coverage because it makes Marketing unhappy. And as the portfolio matures further, eventually the coverage will increase back, probably from Q3 2015 onwards. Kevin. Keep up the good work and keep being prudent Kevin.
You are the best to know whether the calculations need tweaking in the future due to the reasons you outlined above. Any tweaks should be for sound reasons - good to know they won't be for marketing reasons. It would be good to know if you do make any major changes in the future.
The coverage ratio has fallen from 2.26 I see from the post from moneyball in September, to 1.54 for all the reasons that have been outlined - "it is what it is". At least we know.
I am assuming from your note that you think the ratio may well fall further before increasing - but I may have assumed too much from your note :-) It's good to have that information so I won't be so concerned if the ratio continues to fall as lending increases.
I am sure there is a coverage ratio at which I'd stop lending any new money but to be totally honest I don't know what that ratio is yet.
Personally - I wouldn't say I'm "relaxed" about the provision fund. But it does give me a level of assurance that I am comfortable with and I continue to lend more new money on ratestter than other P2P platforms
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Post by westonkevRS on Jan 23, 2015 23:44:10 GMT
As a further update on the coverage ratio, a minority of our loan products have been changed to charge the credit fee over the lifetime of the loan. This means lower up front fees for the borrower, and a structure more aligned to a typical bank loan.
This does put further downward pressure on the coverage ratio as we are now booking balances and estimated losses with no immediate Provision Fund contribution. Therefore decreasing the coverage ratio every time we approve one of these loans.
This might (and probably is) counter intuitive from a marketing perspective, as lenders who use the coverage ratio as their perceived estimate of platform safety could get cold feet. But we are confident in the size, strength and sufficiency of the Provision Fund and so have made these changes recognising the impact.
Kevin.
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jlend
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Post by jlend on Jan 24, 2015 10:23:40 GMT
As a further update on the coverage ratio, a minority of our loan products have been changed to charge the credit fee over the lifetime of the loan. This means lower up front fees for the borrower, and a structure more aligned to a typical bank loan. This does put further downward pressure on the coverage ratio as we are now booking balances and estimated losses with no immediate Provision Fund contribution. Therefore decreasing the coverage ratio every time we approve one of these loans. This might (and probably is) counter intuitive from a marketing perspective, as lenders who use the coverage ratio as their perceived estimate of platform safety could get cold feet. But we are confident in the size, strength and sufficiency of the Provision Fund and so have made these changes recognising the impact. Kevin. Thanks for the update - it's good to be kept informed so we understand some of the reasons for the coverage ratio falling over the coming months.
I appreciate you have to continue tweaking your loan products to meet market demands. And assume you are being careful which loans are given the opportunity to spread the credit fee.
Would I be correct in assuming that you still currently think this "And as the portfolio matures further, eventually the coverage will increase back, probably from Q3 2015 onwards." which you said on January 18th?
Or have you adjusted your thoughts based on this minority of loans?
Keep up the good work
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Post by valueinvestor123 on Jan 24, 2015 11:19:41 GMT
I am not sure there is any point in having any provision fund. In a stampede (due to liquidity squeeze or anything else that will be entirely unforeseen) no coverage ratio will be big enough. If anything, a provision fund may provide a false sense of security and decrease returns due to both smaller perceived risks and also dead money. I think investors are better off making their own 'provision fund'. Perhaps it's a little like with the Income Investment Trusts; most of them hold back some revenue to smooth out dividend income fluctuations over the years which can happen. It's a crude mechanism but I think it impacts returns because it's dead money just sitting there. It's more efficient to actually provide for this yourself by having a margin of safety with your dividend income and reinvest the surplus income back into the portfolio to get the compounding benefit.
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spiral
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Post by spiral on Jan 24, 2015 16:02:24 GMT
I am not sure there is any point in having any provision fund. In a stampede (due to liquidity squeeze or anything else that will be entirely unforeseen) no coverage ratio will be big enough. I don't see the link here. The PF would not and is not intended to do anything in a liquidity squeeze. If everyone on the platform wanted their money back tomorrow, they would remove their on market funds and try to cashout their loans. The problem would be that with no money on the platform, no one would be able to cashout so we would all be tied in to the term of the loan. The PF is only required to make good defaulted loans and the liquidity squeeze has nothing to do with that. Possibily if the PF appeared to be failing (and it wouldn't with a larger coverage ratio), you may create the scenario I just mentioned but before that point the PF would become actively managed which would allay the fears of total losses. I suspect the reality of the situation would be that if a large majority wanted to bail out, they would be able to at a price because of the market place that exists, the 5 yr loans may reach 20%+. This in itself would become self limiting as a high majority that wanted to sell out would stay put when they see the cost of selling (something that currently prevents some from selling out at current rates) and there will always be someone willing to by at the right price. An interesting thought here is that with RS high sellout fees, it may be possible that if the PF was failing which caused large numbers to try and bail out, they may recoup enough fees in order to bail out the failing PF.
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webwiz
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Post by webwiz on Jan 24, 2015 16:18:32 GMT
davee39 says: In a highly competitive market any reduction in provision fund contribution does NOT lead to higher lender rates, but to lower borrower fees, allowing more borrowers to be attracted.If the PF was reduced or eliminated RS would have to offer lenders better rates to compensate, so it is effectively lenders who fund the PF, in the same way that it is house sellers who indirectly pay stamp duty, and consumers who pay VAT although in all three examples it is the other party that hands over the cash.
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Post by davee39 on Jan 24, 2015 16:35:10 GMT
There are other options which pay high rates at the Lenders risk. That is not the market RS is after. The provision fund allows RS to target less sophisticated lenders with a real alternative to the Banks. The introduction of the P2P ISA will allow further targeting of lenders who are uncomfortable with risk (Me!). The success of this innovation is confirmed by its imitation by most other P2P players at the same level.
I am more than happy with the current rates for a relatively secure investment, I am sure though there if there was a real market gap for unsecured high rate lending without a provision fund it would be filled. Anyone mention Yes-Secure?
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sl75
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Post by sl75 on Jan 24, 2015 17:08:34 GMT
As a further update on the coverage ratio, a minority of our loan products have been changed to charge the credit fee over the lifetime of the loan. This means lower up front fees for the borrower, and a structure more aligned to a typical bank loan. As I recall, this was how RateSetter originally worked with the first few loans after launch - switching to the current model presumably due to concerns over the short-term impact on the coverage ratio of having the at-risk capital appear immediately on drawdown but the fees to cover it arriving only later.
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Post by westonkevRS on Jan 24, 2015 20:59:10 GMT
As a further update on the coverage ratio, a minority of our loan products have been changed to charge the credit fee over the lifetime of the loan. This means lower up front fees for the borrower, and a structure more aligned to a typical bank loane. As I recall, this was how RateSetter originally worked with the first few loans after launch - switching to the current model presumably due to concerns over the short-term impact on the coverage ratio of having the at-risk capital appear immediately on drawdown but the fees to cover it arriving only later. Bloomingecok, your good. It was originally like that but only for a matter of months before switching to up-front. We haven't gone back to that model, it's only a selection of new loans. Not a majority by any margin. Kevin.
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