FC Interest Rate Changes

We've all assumed that these rate changes represent an overall sizeable net reduction in rates. I certainly thought so and found FC's claim that the net expected return would be 7.0% (compared with the 7.1% they were saying before) to be quite incredulous. But I was wrong. I have analysed the loan book from the introduction of fixed rates last year up to a couple of days ago and I find the results quite surprising.

There have been, by my calculation, 4,380 fixed rate loans issued to the Retail market (including WL rejects) in that time, of which 612 are Property, leaving 3,768 SME. I exclude Property from my further analysis as there's no indication that these rates will change. Total loan value of these 3,768 SME loans is £237m. The average interest rate, weighted by loan amount, is 10.00%. If all these loans were issued at the new rates, the weighted average rate would be 9.91%, a rather small reduction.  A key factor in this is that the low band rate reductions are lower and the high band rate increases are higher on 5 year loans than on the shorter loans, and 5 year loans account for 64% by value of all these loans.

Moreover, if the calculation is, as it should be, weighted not only by the value of the loan, but also by its term, the weighted average rate has been 10.11% and would fall only to 10.10% on the new rates.  A+ loans make a contribution of -0.31% to this comparison, A -0.15%, B -0.03%, C +0.16%, D +0.19% and E +0.14%.  The total value of D (5%) and E (4%) loans is quite small (A+ is 33%), but the rate increases on D and E are substantial.

So I conclude that FC's projection of the impact of this change is probably correct (in so far as it goes).  But of course, there is a very important assumption underlying this comparison which is that the same amount and mix of business would have been written on the new rates as was done on the old rates.  Without a shift in the grade assessment criteria (and, of course, we know Flexible Categorisation wouldn't do that ) this surely won't be the case according to pure market forces as they will now be much more competitive at the A+/A end of the market and much less so at the D/E end.  So surely either the weighted average return will go down, or the risk will go up.  Either way, investors will have to take more risk to generate the same return.

I hope this helps add some facts to the emotion!

Nov 2, 2016 8:45:14 GMT GSV3MIaC said:

/mod hat off

The short summary is 'lower rates on A+ loans which there are lots of, and will be more of, higher rates on D/Es which are as scarce as hens' teeth, and are shortly going to be extinct'. 8?.

Quite right. And this is deliberate, I think, because they cannot afford the staff time to manage the D & E loans. They get the same fee for an A+ loan which just repays without any work on collections and recoveries.

And another thing, that claim to 7% net (weighted average) is not what can be expected by an autobidder, since it is buoyed up by large property loans at 8%+ (unchanged), which by diversity rules will be much less of a factor in an autobidder portfolio. I reckon an autobidder will lose about 1% and will be very lucky to get 6.5% going forward. They really need that IFISA.

For me it is now only property loans at 10% or above, sold before the end game.

Just to clarify, I was not disagreeing with acky's valuable analysis, that the net return on all non-property loans offered on the partial board since fixed rates would not be much less using the new rates. However, there have been two significant changes during that time. Firstly that the E band loans which were once systematically avoided by whole loan lenders are now taken. So that over the whole period since fixed rate 5% of partial non property loans were E. But over the last 500 partial non-property loans only 2% were E. Going forward the effect of reduced 60 month E loans on the partial board will increase the reduction. Secondly, the whole loan lenders are now taking no property loans at all, which means that the mix on the partial board is further distorted in favour of A+.

What I mistrust is FC's claim that for the 100 loans before 19th Oct, the well diversified lender (assuming the partial board used?) would expect to make 7%. Of course starting from scratch that new lender would get a piece of all the property projects at the higher rates they now have. And presumably they would include all the D & E loans, which in practice does not happen. Going forward the Autobidder would soon find that the 7% was quite unattainable.