RateSetter Q&A Session

We held a Q&A session with a group of investors in the middle of October. We wanted to capture the main points so that all investors have access to the same information. (Please note that the figures below are correct as of the middle of October but some may have changed since then).

Loan performance and the Provision Fund

Q. Can you comment on the performance of lending over time?

We publish performance data for each cohort of loans on our website. The Provision Fund Interest Coverage Ratio has varied over time, it has increased in the recent months and currently stands at 132%. Looking ahead, Brexit adds a degree of uncertainty as it is unclear how various Brexit scenarios may affect the economy and ultimately borrowers. The key thing for us is to manage the Provision Fund well as we go into this period.

Q. Do you factor the economy into Expected Loss figures?

We factor the economy into the Provision Fund by managing the Interest Coverage Ratio above 100% rather than factoring it into the Expected Loss number. We could do this differently, in other words we could factor the economy into the Expected Loss figure and manage the Interest Coverage Ratio to 100%.

Q. The Coverage Ratio has increased but underlying data appear to have gone down. Why is this?

As loans repay (and as defaults come through) they reduce the Provision Fund Expected Future Loss figure.

2018 loans had a higher Expected Future Loss than loans written to date in 2019 (4.8% in 2018 and 3.5% in 2019). 60% of loans (by value) written in 2018 have repaid so far which has reduced the Provision Fund’s Expected Future Losses figure. Loans written in 2019 have added proportionately less to the Provision Fund Expected Future Losses figure. This has moved the average Expected Loss across all years of lending down to 3.5% from 3.6%. This may look like a small movement, but it results in a material the change the Provision Fund Coverage Ratio.

Q. What is the experience of property loan performance?

We have been writing property development loans since 2014 and to date have funded more than £700m of property development finance deals. Property loans account for around £170m of the active loan portfolio. Property loans pay into the Provision Fund, and to date the Provision Fund has not had to pay out for a property loan. We always get professional valuations and we monitor the developments closely with monthly reporting. We only lend to experienced property developers, who must have skin in the game and contingency funds available. Typical property development projects we lend to are for around 8 dwellings or the refurbishment of a building into flats, with a typical project timeline of 9-12 months followed by a sale period of 3-6 months.

Q. Are the Expected Future Provision Fund Inflows payments from loans you will write in the future?

The data we publish on Expected Future Provision Fund Inflows is money we expect the Provision Fund will receive from loans already written to date – not from loans we will write in the future. We apply a discount to this number to reflect that some loans repay early and some loans do not repay.

Q. If RateSetter stopped lending today, would the Provision Fund have enough money? If it ran low, could existing borrowers pay more into the Provision Fund?

RateSetter is highly incentivised to extend our track record of risk management and the Provision Fund’s record of protecting investors.

We can’t change the APR on loans we have already written. However, as loan performance trends play out over a period of months, we can spot emerging trends in performance and have a range of tools with which we can respond. For example, one tool is to adjust pricing on new loans to put more into the Provision Fund. High quality borrowers are price-sensitive, so we manage pricing carefully.

If the Provision Fund was not able to cover Expected Future Losses, investors could receive a reduced level of interest for a period of time, with the interest foregone flowing to the Provision Fund to strengthen it. If the outlook got worse and investors’ capital was at risk then investors’ capital and interest could be reduced, with the foregone capital and interest going into the Provision Fund to strengthen it.

Investments

Q. Will you take rate-setting away from investors?

No, this is not a consideration. Many investors enjoy this unique feature. Money put on the market at different interest rates also provides liquidity which is a benefit to other investors who wish to access their money – helping RateSetter to maintain the strongest track record of liquidity in the P2P sector.

Q. What are 1 Year and 5 Year products used for now?

The 1 Year product is focussed on property loans, although we also finance property loans from our other investment products too. There are no specific restrictions on other products – it’s a matter of supply and demand.

It’s early days for our new products, but we have seen some investors moving money into them from the 1 and 5 Year products. We intend to keep the 1 and 5 Year products as they are now, but one can envisage a time when we no longer offer these products as people stop using them if it is in the interest of investors to do so.

Q. How do you decide which market funds each loan? How does investor money at higher rates get matched?

This is determined by supply and demand.

We put approved loans on a market depending on the supply of that market. When a new loan is approved it is put onto a market at 0.1% below the lowest investor offer at that time as this allows an investor wanting to match their money quickly to take that rate. If the loan order is not matched, it is then put into the borrower queue and matched with investors on the market.
When all the money from investors at the lowest rates is matched, we move up the offer queue to match money at higher rates.

Of course, the investor’s interest rate and the borrower’s APR are two separate things – and how they are set necessarily differs.

The APR of a loan includes three components: the investor’s interest rate, credit fees (paid into the Provision Fund), and RateSetter’s fee.
Credit fees are determined by our credit risk teams who will assess the contribution required to the Provision Fund given the risk of default by the borrower.

We can revise APRs over time as we write new loans but they do not fluctuate within a short period of time, so it is RateSetter’s fee that varies to ensure that both the Provision Fund and investors receive what they expected. When investor rates are high, RateSetter may choose to take a lower fee or a loss.

Greater stability in investor interest rates allows us to plan loan originations with greater certainty, which helps us to target lower risk borrower segments. It also reduces the likelihood that RateSetter’s fee has to be squeezed, which strengthens the platform.

Q. How does RateSetter manage liquidity?

Investments with RateSetter are self-liquidating – that is, invested money is paid back as borrowers make repayments. Each month around £50m comes in via borrower repayments. £20-30m comes in from new investments each month. This means there is £70-80m of liquidity each month, from which we can process withdrawals and match to new loans. If there were an increase in money wishing to leave the platform, we would write a lower value of new loans.

If an investor were to sell out of an existing loan and then reinvest at a higher rate in the same loan, RateSetter would have to make up the difference in rates. The Fair Usage policy in the Access product helps manage this.

Other topics

Q. Does RateSetter refinance loans so the rate is lower?

RateSetter does not do this. Loans are only matched to new investors if the investor who is already matched requests to release their investment. If an investor receives an early repayment of the loan in full, this could be a result of either an early repayment by the borrower or the Provision Fund.

Q. Why did RateSetter stop publishing some of detailed data it used to publish?

We are committed to transparency and proving customers with information that will help them to assess the performance of the investment. We removed some data where it was clear that the information was not widely understood and, without deeper insight and context, was at risk of causing misunderstandings. This was particularly true of the loan book data.

Q. What is RateSetter’s wind down plan and how would it be paid for?

We will publish more information on this shortly. Forthcoming FCA regulation will require all platforms to do so. The important thing is that in a wind down scenario at RateSetter the risk of investments would remain spread across the whole loan portfolio thanks to the Provision Fund.

All platforms must put funds aside to be able to deliver their wind down plan. Also, fees would continue to come into RateSetter as active loans repay which would provide a stream of resources.

Q. When do you expect RateSetter will be profitable as a business?

We are focussed on becoming profitable - our latest financial results for the year ending March 2019 show a big step towards profitability.