May 14, 2018
Credit is at the very heart of our business and rightly so as it creates your net investment returns.
You, our investors, have now earned well over £40m of gross interest in our first five years. This strong level of income comes from our specialisation in secured business lending and the respectable interest rates that we can charge to businesses who can provide security for those loans.
Deciding who to lend to, and who not to lend to, is the part of credit called sanctioning. Sanctioning of a loan is based upon many factors and we continue to develop this part of our business in order to seek to take on loans that can deliver consistent and healthy levels of interest rate. This consistency and level of return in turn depends on not having too many defaulted loans that then need recovering by sale of their security. Our recent move to solely providing property secured lending is also part of that wish for consistency.
As our scale has grown, so our credit processes have also evolved over time. Our ever-growing credit team, and their huge depth of experience, permits us to apply a policy of continuous improvement and nowhere more so than our loan servicing and monitoring. The business of lending is seldom 'fire and forget', meaning that the work that goes into monitoring loans through their lifetime by seeking to anticipate and manage issues that may arise along the way is of equal importance to the original sanctioning of those loans. We are updating and simplifying how we categorise the status of individual loans, both internally and externally. This is to ensure that you have a clear understanding of what state a particular loan is in at any time should you wish to look, and also to explain better what we do about challenges that arise from time to time during the life of those loans or at the end when they are due to repay. Whilst many investors may be most interested in the simpler automatic investment accounts we have gone into a lot more detail in the associated blog below for those that would love to know a lot more about how we work.
One area that we feel sometimes leaves something to be desired by the industry is the clarity and consistency of reporting loan performance including defaults and recoveries. We wish to set ourselves apart with our strong and clear approach, becoming recognised for good practice in the industry. This is intended to be in terms of credit policy, processes, net returns after losses and above all, transparency and we have also today updated our Defaults and Losses statistics webpage.
Credit and everything about it can influence the investment returns for investors and can also influence the level of financial support that we can provide to UK businesses needing funding. Getting that balance right will help us continue to deliver attractive rates of interest to yourselves and much needed and affordable capital to businesses across the UK.
The Difference between Defaults and Losses
Our business has one substantial difference to a simpler, unsecured lender and that is that we take property security on every loan that we issue so that we can seek to recover the some or all of the balance of the loan if it defaults - not something that is very easy if the loan is issued unsecured.
It is part of our credit sanctioning process to check if a business can afford to repay the loan that it takes however it is also important for us to ensure that you, the investor has strong security of capital in the event of the borrower unexpectedly defaulting on their loan. Those are our two prime tenets for lending. Whilst there are no guarantees, even with property security, that future events won't lead to some loss of capital on a difficult loan, it is our goal at the outset that a loss is sought to be avoided even if a loan defaults.
Our overall loan book shows that we lend less than 65p for each £1 of property security that we take for those loans. Another way to express this is that this loan would be 65% loan to value or LTV as it is abbreviated and that a property would have to be sold with around a 35% price reduction for it to not cover the amount of the loan. This is relatively conservative lending and I'm sure people remember the news headlines in the last crisis where some mortgage lenders were lending well above the value of the security they took for the loans. This is not a practice that we condone, and it is our relatively high level of security that helps us aspire to recover most or all of a loan in the event of it defaulting. Nonetheless, as a business, we create the interest rate level that you receive by operating in the next band of businesses that are one step beyond where banks mainly operate. This may give an expectation of security covering a defaulted loan and usually avoiding a bad debt but our level of default rate across our loan book is expected to be a little higher than a bank’s. Our business is about pricing loans for that default risk in order to deliver consistent net returns after any recoveries.
Nonetheless, unexpected events can sometimes lead to the property recovery not providing full proceeds against the loan. It is these occasions that could lead to losses but the purpose of taking such security on our lending is to attempt to avoid defaulted loans becoming losses. To this end we do report default statistics but at the same time it is the strength of our recoveries and our security that shows itself in our modest losses across our loan book over time.
To help reduce the risk of loss from the occasional bad loan affecting your total returns too much we suggest that lenders consider investing across many loans so that the performance of one individual loan is not too significant in the context of your loan portfolio as a whole. A quick and simple way to achieve this is to invest through the Access Accounts where there are hundreds of loans that you would be automatically invested across. Our other investment accounts such as the Property Secured Account (PSA) are less diversified as they have more restrictive criteria for loans to be included within them but all of our automatic investment accounts also offer provision funds. These seek to cover and smooth out late monthly payments from otherwise normally performing loans and seek to cover any capital shortfall in the event of the security, when realised, not fully covering the remaining loan capital. The provision funds are not a guarantee that a target return will be achieved but the combined benefits of automation, diversification and protection are designed to offer an alternative to the greater time required to invest through our Manual Lending Account (MLA).
Sanctioning of loans is the process where the credit risk of a proposed loan to a borrower is evaluated and we decide whether or not to lend them the money requested. The process can be very involved and relies on deep experience, as well as common sense, and our risk appetite is driven by the credit policy of the business. Our credit policy is designed to deliver affordable lending to businesses who we consider are very likely to repay the loan in full and without default but that also offers us sufficient security, solely property nowadays, as collateral for the loan in case it does.
The loan sanctioning process actually starts out in the field through our nationwide team of highly experienced Relationship Directors (RDs). Think of them as the almost extinct business bank manager role, someone that knows your business, can visit you face to face and review and help structure your loan application. Banks may not like employing them anymore, but we believe they are essential to knowing your customer and starting on the right foot.
Our RDs are our front line and have the decision-making authority to reject loan applications at an early stage if their experience tells them that the application is not one that could or should be supported. In other cases, the loan application may not be initially well suited to our credit appetite but could be structured in a different way to make it safer for all parties. This is sometimes done by the RD directly, or done in conjunction with our credit sanctioning team who could be involved in looking at a borrower's application within just 24 hours of it being introduced to the RD. This is radically different to a bank where often loans make it a long way through the process before the credit sanctioning team see it, which can lead to frustration for all if it is knocked back.
We don't use computers to make our credit decisions, just to help with the loan processing, and our RDs provide a face-to-face service in order to make judgements on other components of the credit decision such as the identity and experience of the borrower and the RD's view on the business itself.
Loans that are for suitable for putting up to full credit sanctioning have document packs put together by the RD including a credit report and lots of other documentation to support the affordability of the loan, the valuation of any security through an independent valuer’s advice to us and any other factors important in each particular case. The loan then goes through the process of sanctioning and it could even require board level sanction, in addition to the credit team's approval, if the loan size exceeds certain levels.
Each loan will have its own set of legal conditions that need to be satisfied before the loan is drawn down as well as conditions built into the loan documentation that must be satisfied during the life of the loan. A breach of the latter is what can lead to a loan default later on if the borrower does not continue to comply with those conditions, such as providing monthly management accounts, paying interest each month, maintaining a certain level of profitability or cash generation and so on. It is these subsequent loan conditions that are looked after by the loan servicing and monitoring team as below.
As part of our previously publicised simplification of our business we have also recently decided to cease sanctioning of all non-property secured lending meaning that we no longer lend to businesses who cannot provide that property security. For this and other reasons it has also meant that we have also recently stopped providing renewable energy/ wind turbine loans although that market is now well established and contributing hugely to the UK’s energy generation needs. This change fits with our aim of providing you with consistent income from strongly secured lending.
Loan Servicing and Monitoring
Loan servicing is sometimes just thought about as the collection of the regular loan repayments and payments of interest, but it is necessarily much more than that if the lender wants to stay on top of their loan book and the risks within it. Loan monitoring at a simple level is ensuring that a loan stays compliant with any conditions that must be satisfied for the life of that loan. As we mentioned above, this could be things to do with providing regular management accounts for the business through to specific covenants that the borrower has agreed to comply with that help us control the risk in a loan. There can also be other information that the borrower must provide regularly to us that, whilst not specifically a loan covenant that must not be breached, help provide information that can help the loan servicing and monitoring team stay on top of the performance of the business and any risks within it. One of the most important aspects of loan monitoring is to seek to achieve early warning of potential problems ahead. These may just be risks that we seek to understand better or they could be risks that have now become issues and are specific challenges for the borrower. Understanding and foreseeing issues helps us provide potential support to that borrower that may help them eliminate those issues and return to health, avoiding a loan default and all the costs associated with that.
No one likes surprises and our loan servicing and monitoring team try to stay ahead of what is developing within a borrower's business as that can help with achieving the best outcome for both the borrower and the lender. Staying ahead provides time to plan.
One important part of knowing where a loan is up to is setting Loan Status codes for both internal and external use so that we know whether a loan has issues and at what stage those issues may have developed to. These codes also mean that we can publish information to our investors about specific loans and the condition that they are in. We have recently sought to standardise and simplify our loan status codes and we talk about this more in the relevant section below. The purpose of the simplification is to minimise confusion over where a loan is up to and any risks that may exist within it. Loan Status codes also tells you at a high level what we are currently doing with the loan.
Sometimes a loan moves beyond having problems that are handled by the loan servicing and monitoring team and it needs to go into recoveries. Often this means that the loan will be transferred over to external administrators or receivers in order to recover the outstanding balance of capital on that loan by sale of the security that we took at the time of offering the loan. Nonetheless, there are many situations where the cost of these professional appointments and also the more limited choices that an administrator or receiver has at their disposal could mean that we seek alternative routes to recovering a loan before passing it out externally.
Administrators and receivers can cost a great deal of money and this money is paid for firstly by the borrower, if there is enough value in the security taken for the loan, and if not then it is effectively paid by you, the investors, out of the capital recovery from selling the loan security.
Professional recovery teams also have legal limitations on what they can and cannot do and this to could justify seeking an alternative recovery method initially. Sometimes there are alternative routes that may be proposed by the borrower that may well be able to achieve a higher capital recovery outcome for investors and as an alternative lender this is one of our opportunities to deliver better outcomes for both investors and borrowers and we will actively review the opportunity for this before putting a borrower into administration or receivership.
Our in-house recoveries team is very skilled at going through the external professional advisory route for a recovery, but we also continue to build our skill and our processes for assisting better recoveries internally.
When a borrower has difficulties, one of the first things that we do is to seek proposals from the borrower so that we can assess them and put them to investors, where appropriate, to vote upon. Protecting investors’ capital is the primary focus when reviewing proposals from borrowers and when we put them to the vote, investors can either accept or reject the borrower’s proposals.
We will continue to develop our business to provide the best possible service to our investors that we can, whether using external professional advisers or not.
Our Revised Loan Credit Status Codes
We are pleased to announce an updated and clearer definition of our loan statuses and you will find them on the following webpage (https://www.assetzcapital.co.uk/key-investing-information/defaults-and-losses/) . The purpose of these updated loan statuses, and the explanations of the triggers that could cause a loan to change status, is to provide you with greater clarity over the state of a loan. We have taken the opportunity to bring together the terminology that we have used on the website with our own internal status codes in order to have greater consistency and avoid any confusion.
Most loans operate on a 'normal' basis but if we see something relating to the loan borrower that piques our interest but does not as yet cause us undue concern then we look closer and more often at that loan.
If the loan has not been repaid within 60 days of its due date or is behind by more than 60 days with its regular loan repayments, or we have material reason to believe that the loan may not be able to fully repay when due then this is known as a 'credit event' and the loans are known as non-performing. Loans that have a 'credit event' and are non-performing could return to 'normal' conditions if they rectify the issue by for example, catching up on payments. However, ‘credit event’ loans can also move into being classified as 'defaulted' if those issues are not rectified within 180 days or where we have material reason to believe that the loan may not be able to fully repay when due.
This means that some loans, based upon information received, could move very swiftly into 'default' status and it is likely that only loans with a low likelihood of a loss would remain in 'credit event' status for the full 180 days. Nonetheless, the significant level of security on our lending should often mean that a 'defaulted' loan does not actually see a loss.
All loans with 'credit events', whether or not also classified as a 'default', have trading suspended on the aftermarket. Currently this means that no one can trade this loan through the Manual Lending Account (MLA) or the other Investment Accounts (such as the GBBA or the PSA). If you seek to sell your entire holding within an investment account, then money invested in any credit event loans will not be returned to you until either the loan goes back into 'normal' trading or it goes through the recovery process and has all or some of its capital recovered. The Access Accounts will however continue to trade these 'credit event' loans provided that the relevant provision fund provides full, ring-fenced coverage for the expected loss on that loan. We are currently reviewing whether to permit informed-choice trading in these loans in the MLA, along with the potential for discounts, and will advise if this feature is released in due course.
Another important change that we have carried out recently is that we have separately specified a temporary loan trading suspension in the loan listing screens whilst a lender vote is being carried out so as to not confuse it with loan suspensions as a result of a 'credit event'.
There has also been a recent and complete re-categorisation of all of the loan book which now shows these new simplified status codes.
Defaults and Losses Web Page Update
We have also now updated our defaults and losses web page by carrying out an analysis of our loan book based upon the revised loan credit status codes above. Being a secured lender, we feel that the most important numbers for our investors are the expected losses on loans after the recovery of capital (by selling the security for those loans) but we also show the default levels for problem loans before those recoveries. Alternative finance often focuses on businesses with a slightly higher risk of default than high street banks and this is what permits loan interest at our types of levels rather than the lower rates typically charged by the high street banks. We believe that the slightly higher risk of default combined with the cautious level of security that we require for those loans should offer some mitigation against the prospect of material losses, even if there is a default, but it does permit us to charge a higher interest rate that we then pass on to yourselves. Occasional defaults create additional work for us but the cost of this to ourselves is acceptable versus the additional interest rates that this permits us to pay you.
As part of our work with the loan status codes described above, we have taken the opportunity to standardise something that often varies greatly within lending businesses. We have taken the step to become even more rigorous and consistent with our classification of 'credit events' and 'defaults' and to utilise an independent best practice approach to this recognition process. We have therefore decided to adopt the European Banking Authority (EBA) classification of loan defaults which we believe may be adopted by the Bank of England (PRA) here in the UK as part of a ‘harmonisation’ exercise. It is for this reason that we have not adopted the Peer-to-Peer Finance Association's default and loss definitions and instead have chosen what we consider to be clearer and more rigorous EBA standard combined with the normal FCA disclosure requirements. The result is some higher default rates but, as explained above, losses after bad debt recoveries remain very strong versus the industry as a whole.
We are pleased to continue to deliver strong investor interest rates after all losses net of recoveries and we believe that we are performing relatively well versus the other ‘big four’ peer to peer lenders in that respect.
The new defaults and losses web page also contains updated provision fund coverage data and we are planning to update our stress testing results in the near future, utilising the latest version of the Bank of England stress test methodology also applied to banks.
We take the responsibility of looking after your capital and delivering a healthy rate of interest upon that capital very seriously. We will continue to build the best team that we can and will also continue to seek to be as transparent as possible on our loan management processes and our overall investment performance. The business of lending can be complicated but many of you want to know that detail and we will therefore seek to make sure that those of you who would like this information can readily access it whilst also looking to keep our communication simple for those who wish to have a simple relationship with us.
We want to deliver you the best service that we can and in the most transparent way. To that end, we will continue to listen to you and take your feedback on board where at all possible.
Thank you again.
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