We’re introducing a new risk band and renaming C-

We’re excited to announce that we’re introducing a sixth risk band, to help more small businesses access finance, whilst offering investors more borrowers to lend to. These loans will be listed on the marketplace over the coming weeks. Here’s what you need to know:

1. Introducing E

The new risk band will be called E and will offer an attractive risk-return profile for investors. The gross interest rates you can bid at for loans in the E risk band will be between 18.2% and 20%, to reflect a higher expected annualised bad debt rate of 8%.

If you’re using Autobid you will need to update your settings to include E, as Autobid will not lend to E loans automatically. We’ll notify you by email when the new risk band has launched so you can do this.

risk band

2. Renaming C- to D in the coming weeks

To make our risk grading simpler, we are going to rename C- to D. Over the next few weeks, all loan parts you hold which were C-, will be renamed to D. This will be reflected in your summary page, and we’ll confirm once the change has been made.

Our risk bands will be:

A+, A, B, C, D, E  where A+ is lowest risk.

This does not mean that C- loans have been re-assessed or have higher expected bad debt rates than they did before. We’re simply changing the name to make the risk grading easier to understand.

3.  The evolution of risk bands at Funding Circle

In 2010 we started with 3 risk bands: A+, A and B. We launched C in September 2011, and D (formerly C-) came in July 2013.

Adding our sixth risk band, E, is a natural step. We have been tracking the performance of all businesses who have come to Funding Circle, including those whose applications were declined, for more than 2 years so we can estimate the risk of these businesses.

4. Estimated returns for all risk bands

For each risk band, the table below shows:

  • the minimum bid rates for each risk band;
  • the estimated annual bad debt rates;
  • the estimated returns (based on minimum rates) after fees and bad debt, but before tax.

Actual returns may be higher or lower and your capital is at risk.

Risk table

5. Higher interest rates to reflect greater level of risk

The minimum bid rate of 18.2% for E loans has been set based on a range of factors including the risk and volatility associated with lending to these borrowers, macroeconomic factors and competition in the market. Estimated returns are therefore higher on E loans, and this is to reflect higher estimated bad debt rates and greater volatility.

It’s worth remembering that estimated bad debt rates are no guarantee of the actual bad debt you will experience for each risk band, so we would recommend spreading your lending across lots of borrowers in different risk bands to reduce the impact of any single bad debt. You can read more about how to do this in our blog about diversification.

6. Helping small, creditworthy businesses

We will still only allow creditworthy businesses to borrow through the marketplace, and every loan application will be assessed by our experienced credit assessment team.

Businesses who have loans in the E band may generally have lower profit after tax than other risk bands – not because they have poor payment performance.

A Delphi score (from Experian, a third party bureau measure of business risk) is one of the many factors which are considered when we assess a loan application. We expect E band loans to have an average of 62/100, which is higher than the UK average of 45 for small businesses.

delphi score

How can you lend to these businesses?

You will see the first E loans listed on the marketplace over the next couple of weeks, and you can place your bids as you would normally. The highest gross interest rate you can bid at will be increased to 20%.

Do you use Autobid?

If you’re an Autobid user you will need to update your settings as your Autobid will not automatically include E loans. When E loans launch, turn your Autobid off, tick the box beside E to include these loans, and turn it on again. Remember by lending to businesses your capital is at risk.

Join us on the forum where we’re discussing this news. If you have any questions at all, please contact us and our team will be happy to help.

Enjoy lending,

The Funding Circle team

Jack Pritchett

Customer Communications Manager

 

16 thoughts on “We’re introducing a new risk band and renaming C-

  1. I accept that you’d want to set the minimum bid rate for risk band E much higher than for risk band A+ (say), as the former has greater risk of default. What seems very odd to me is that you set the E figure to give a higher ‘after fees and bad debt’ rate’ (9.2% for E vs 4.4% for A+). You’re penalising the firms in risk band E twice. I would have thought the expected rate after fees and bad debts should be the SAME for all risk bands. Plus, as an adult, I’d expect to be able to set my own minimum rates.

    • Clive, where is the point in having the same return after fees and bad debt for different risk bands? Of course there MUST be a better return for a higher risk. If you can choose between someone who will repay you with 99% certainty or someone else who will only repay with 90% certainty, you’d choose the 99% if both were to offer the same return.
      People will only bid on high risk loans, if the after fees & bad debt yield is higher, than on the low risk loans.

      • Andi.
        I’ve just checked the Statistics page for the last 50 loans, looking at the average gross rates. A+ 8.3%, A 9.4%, B 10.1%, C 11.2%, C- 13.0%. Autobid says those rates equate to returns to the lender of A+ 6.7%, A 6.9%, B 6.8%, C 6.9%, C- 7.%. Hence, people (not just me) are asking for very little risk premium for C- over A+ (7.0% to 6.7%). You get benefit from riskier loans because their default rates to date have been a lot lower than FC suggest and that gives you a bigger return.
        FC suggest there should be 1.8% difference in after fees/bad debt on risk D vs risk A+. FC should accept that some of us (OK, maybe not you/others) don’t feel we need such a high premium and lower their E minimum rate.

  2. As you might expect, the new E band loans with the 18%+ headline rate are instantly being snapped up by the usual mob of traders. So unless you’re happy losing a few percent to the secondary market you’d have to be either lucky or fast to be able to bid on one of these anyway.

    • Seems that FC are defeating the purpose of their website – namely, to have a competitive auction to find the LOWEST rate us lenders are willing to lend at. I’d be quite happy to go lower than 18.2%, but FC don’t allow it. Very odd.
      Come on FC, allow capitalism to set the rate.

      • Trouble is…that whilst Traders are allowed an unlimited number of bids their bidding will always drive the rate much lower than if it were only us lenders bidding. As long as the rate is still considered a good return on the secondary market the Traders have no care what rate they drive as they will always take their 2-3% premium when they sell it on. I agree that removing the floor would allow capitalism to set the rate however the Traders have no visible signs of self control so the E rate would probably be driven down to 10-12% anyway until enough people get burned with the defaults and the new level emerges. Either way the final yield would probably settle around 6-7% like all the rest. I can’t see it changing until the original bidding process becomes free and fair, but whilst FC makes money out of the Traders’ activity – by effectively selling the same thing twice – that isn’t going to happen. Incidentally, you have to accept that the real purpose of the website is to make FC a profitable business, not to find the lowest rate us lenders are willing to lend at. That’s true capitalism 😉

        • Agree with you on that (purpose..make FC a profitable business). I rang FC today saying I thought they were disadvantaging most lenders – can’t get into an auction that lasts an hour/two – and most risk E borrowers. They just wouldn’t accept the point. FC said the borrowers could refuse the loan if they didn’t like the rate. However, as FC explain the minimum rate to them before listing, borrower is hardly likely to reject it when it comes in at that minimum (18.2). I said “but, you don’t explain that Clive may be willing to lend at (say) 17% but you won’t allow it”. No answer.

          FC said they’d introduced minimum bids in the first place because some lenders didn’t like how low the rates were going. When I see loans still open but where the rate is below what I want to lend at, I just don’t bid. I don’t ask FC to support the market at my chosen rate.

          I mentioned to FC that a) loans getting filled at 18.2% within an hour (literally),and b) lots of those bids going straight to the Loan Parts market at a 3% premium (as you suggested it would) were two signs they’d set the minimum way too high. The most I got from FC was “thank you for ringing, I’ll pass your comments along”

          • C’est la vie. On balance I’d rather FC operate in their own interests given that they are now, effectively, my bank. I don’t want them to go bust whilst my money is lent out. If I can’t get onto any E loans then so be it. My bigger disappointment with the new E loans is that my new business is only 2 years old and I always expected to get a loan through FC sometime. 12-13% for C- was a lot more palatable than 18-19% that I’d get now. Anyway, good luck with your investing.

      • Do not understand this comment ALL bands have a floor on lowest bid rates and the E band is no different

        • There’s no need for minimum rates (FC didn’t have them when they started). Regardless of whether you bid manually or via auto-bid, removing minimum rates wouldn’t force anybody to lend money at a rate lower than they were happy with.

          • I disagree, there is a need for minimum rates. because before these were introduced, there were bidding wars and the final rates were steadily deteriorating, until it wasnt worth bidding. I originally wasnt in favour, but then I saw a big improvement in rates to realistic final rates. furthermore lower credit ratings were often getting lower final rates. whether the 18.2% for E is correct I cannot comment. with the other minimum rates, FC adjusted these later so I imagine this will happen again.

  3. I think in setting minimum rates, FC have the retail investor in mind – someone like me, who has to pay tax at 40% on all interest earned, and but obtains no tax relief on bad debts. I calculate that my expected after-tax rate on these E band loans at 18.2% would be 1.92% (18.2% taxed at 40% less 8% default and 1% fees).

    Removing the floor would allow unwary retail investors to invest at rates that give rise to an expected after-tax loss, and that wouldn’t really be in anyone’s interest.

    • Nigel

      I suspect your last point “Removing the floor would allow unwary retail investors to invest at rates that give rise to an expected after-tax loss” may be it. Imo not so much for the tax aspect, but FC may be worried about investors who don’t read the info on expected default rates and don’t diversify. They could well take losses even before tax. Even though it wouldn’t be FC’s fault, they wouldn’t want investors going to the press saying they’d put all of their money into just a handful of risky loans and got wiped out.

    • Hi Nigel, I phoned HMRC many months ago and spoke to a tax inspector. if I remember rightly you can claim bad debts against capital gains tax. if you lent 400 to a company at 9%, then the 9% is taxed as income tax. but if the loan defaults, then the 400 is a credit for your capital gains tax. ie there is tax relief, capital gains tax relief, but not income tax relief. the actual interest you got until default gets income tax. and the default can be subtracted from your capital gains before you apply the CGT. eg if you sold your house, then you could subtract that from the profit. eg you buy a house for 200000, sell it for 300000, and you lost 4000 capital on defaulted loans. then I think the CGT is on 300000 – 200000 – 4000.

  4. I’m finding it very difficult to lend since the new E band was introduced. I’m prepared to take more risk with my portfolio, but the E bands are never available, and the D bands don’t get as many bids as before, so although there’s a higher rate available, borrowers don’t get the rate they expected, and are more likely to not take the offer. I’m losing count of recent times that I’ve tied my money up to a loan for it to be rejected in the end, so basically a return of 0% for that period. In my opinion, it is too easy/attractive to trade in loan parts, which distorts the concept of a competitive marketplace for new loans. I’m also extremely concerned about how quickly I could “liquidate” my investments due to the sheer quantity of loan parts for sale (e.g. there are currently 367 loan parts on the marketplace for one of the loans I am exposed to meaning I can’t sell any where near quickly without taking a substantial hit).

    • I agree with your comment entirely. I have never sold any loan parts and don’t need to at the moment but a few weeks ago I decided to test the water to find out how easily I could liquidate. I put a B loan with a 10.2% rate up for sale as typical of my portfolio. Initially I asked for a premium reducing the buyer rate to 9.7% (which should be attractive to some investors if you believe the FC blurb) but no luck. It is now on sale with no premium (which I think is unusual looking at other loan parts). Let’s see how it goes. I am gradually resigning myself to the fact that I will have to let my portfolio run its course regardless of my financial circumstances (which is perhaps no bad thing) but in future I will be less likely to take out any long term loans given the risk of tying up my capital for the duration. This is perhaps a consequence that FC need to consider – a large number of loan parts are being ‘flipped’ for a quick profit. Unless genuine investors believe they can get their money out if needed, long term loans may not get the best rate.

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