Digging into the data: improving returns
Since the Funding Circle marketplace first launched, estimated annual returns have increased from 5.7% in 2011 to 7.1% in 2014. In this edition of the Digging Into The Data series we examine how interest rates have changed over time, what has caused these changes and why investors are now earning more.
Gross interest rates (bid rates) have been increasing over time
You can see in the graph below that since Funding Circle launched in August 2010, the average successful gross interest rate has increased 25% from 8.3% to 10.4%. Let’s look at the main reasons for this increase in more detail.
1) Introducing new risk bands has enabled investors to earn higher returns
The Funding Circle marketplace launched with 3 risk bands (A+, A and B) for investors to lend across. As we have grown and understood more about credit assessment we have introduced new risk bands (C and C-) to provide even more lending opportunities to help investors spread their lending across as many businesses as possible.
These newer risk bands have an attractive risk-return profile. Since being introduced in June 2012, more than £103 million has been lent to C businesses with an average gross interest rates of 11% and an expected net return of 6.4%. £32 million has been lent to C- businesses since June 2013 at an average gross interest rates of 13.3% and an expected net return of 6.8%.
2) The introduction of Minimum Bid Rates has gradually increased gross interest rates
In 2013 we introduced Minimum Bid Rates across all risk bands. Prior to this change, the minimum gross interest rate you could bid on any loan was 4% across all risk bands. From the start of 2013 we saw a sharp fall in gross interest rates. As a result, in mid-2013 we introduced minimum bid rates to increase the overall net returns for investors. Since this introduction average interest rates have increased 24% from 8.4% to 10.4% by the second half of 2014.
3) We’re improving our ability to manage the supply and demand of the marketplace
Whilst the introduction of new risk bands and minimum bid rates has helped to increase the overall gross interest rates for investors, these rates fall if there is an imbalance in the marketplace. This means there are too few borrowers for investors to lend to and causes gross interest rates to fall, creating inefficiencies in the marketplace. This is one of the biggest challenges at Funding Circle.
In order to better balance supply with demand we have introduced a number of new initiatives over the last few years. These include TV advertising and partnerships with banks and accountants to increase demand from businesses. We’ve also broadened the types of investors who use Funding Circle to ensure we meet this increase in demand.
Improving credit policies leads to a decline in losses
Alongside increases in gross interest rates over time, improvements in our credit assessment and loan servicing policies have led to increases in the actual returns investors receive.
We publish information about the bad debt performance versus expectations on our statistics page and update this information monthly. These results show that since 2010 our credit assessment policies have consistently improved. This is down to the work our credit analytics team is doing to create better risk models, by using more and more sources of data.
We are also getting better at analysing the propensity of a business to default after they have accepted a loan. Looking at the below graph we can see that in 2013, for every accepted business that defaulted, 4 that were rejected ended up in default, this is a 3X increase compared to 2011.
Finally, the loan servicing team have brought down the number of businesses that are late paying from 1.5% to 0.7% as a proportion of all live loans. When a business does default the loan servicing team work to reclaim as much of the loan as possible. Currently the recovery rate for defaulted loans is 19.4p, and this rate has steadily increased from 14.6p since we started managing defaulted loans in-house. Long term, the expected recovery is anticipated to be ~40p – increasing to 44p for loans that defaulted in the first half of 2014, and 47p for defaulted loans in the second half of 2014.
We hope you enjoyed this post about the improving investor returns on Funding Circle. With future changes such as ISA introduction and new tax relief for investors, we expect that lending to businesses through marketplaces will become even more attractive for investors over time; however it is important to note that interest rates can go down as well as up as your capital is at risk. We always recommend investors spread their lending across at least 100 businesses where possible to maximise their returns. You can read more about diversification on our statistics page.
The Funding Circle team