Jerome Le Luel joined Funding Circle as Global Chief Risk Officer four years ago; bringing with him more than 20 years of experience in risk management. His previous roles include Global Head of Risk Analytics at Barclays Bank and Global Chief Risk Officer at Barclaycard, where he successfully navigated their global portfolio through the 2008/9 recession.
Jerome leads a team of more than 100 risk professionals across the four markets Funding Circle operates in: including data scientists, credit risk analysts and credit assessment experts.
In the latest in our series, Jerome will provide his view on the current macroeconomic climate in the UK and what this means for the businesses you lend to
Some of the conditions driving uncertainty have eased
In my previous update we discussed how in the UK, increasing economic uncertainty was being driven by an unstable political environment. The key fundamentals remained stable in 2019; the economy has grown slowly but steadily and unemployment remains at historic lows. However, the uncertainty contributed to a decline in business confidence, with business investment and borrowing slowing down last year.
UK Small Business Confidence Index
Source: Federation of Small Businesses
We are politically neutral at Funding Circle, however last month’s election result provided some welcome clarity for the business community. This stability will help engender business confidence and as a result, I expect some of the investment that has been held back in recent years to be deployed into the UK economy. This would be good news for small businesses and those who lend to them, although it’s prudent to be cautious—there is still a lot unknown about how the Brexit process will eventually materialise. As always, we will continue to monitor the economic environment carefully and make adjustments when required.
Our performance outlook remains stable
Every three months, we update the projected returns for each group of loans originated since 2012. These are the annualised returns, after fees and bad debt, that loans are trending towards once all loans have been repaid and recoveries received. For each group of loans, we combine the actual annualised return received to date from the portion of loans that have repaid, and our latest estimates for the remaining term of the portion of loans that have not yet been repaid.
Projected returns have remained stable since our last update in October:
Projected returns after fees and bad debt, UK*Source: Funding Circle
Our tightening actions have seen positive results
Previously I have discussed that while the overall performance of UK small business has remained stable in recent years, there has been a small segment of the market that has underperformed. From the chart below, you can see that a rise in the number of individuals that have been made insolvent—driven by a significant expansion in consumer borrowing since 2013—has had a knock-on effect on the insolvency rates of some small businesses; for example those who may be more reliant on lines of personal credit when managing their business cashflow:
UK small business and consumer insolvencies (Indexed, Q1 2008 = 100)Source: Gov.UK
While the large majority of businesses you lend to have performed as expected, the projected returns of loans between 2016 – 18 reflect that a small population of businesses were impacted by this worsening consumer credit environment. In response, we made a series of adjustments to our credit policies and risk models to significantly reduce investors’ exposure to this segment of businesses. You can see one example of this in the chart below:
Average director consumer score (Indexed, Jan 2017 = 100)
Source: Funding Circle
The chart shows how the director consumer scores of businesses we accept on the platform has changed over time. The consumer score is the credit score given by a credit bureau based on the information they hold on a director. While this is just one of the many metrics we use to assess the businesses you lend to, you can see how investors are now significantly less exposed to businesses whose directors have a low consumer score – i.e. are more susceptible to the consumer credit environment.
I’m glad to say this prudent approach has yielded positive initial results. While loans taken out in 2019 are still in the early stages of their term, initial signs are showing improvement over the 2016-18 cohorts. As an example the chart below shows the percentage of loans, three months after being taken out, that were 10 or more days late.
Percentage of loans (by loan amount) 10+ days late, 90 days from origination
Source: Funding Circle
It’s important to be clear that this is just one metric, and is not a guarantee of how these loans will perform over time. We are currently projecting loans taken out in 2019 to deliver annualised returns of 5 – 7% after fees and bad debts.
Putting your portfolio through its paces
The increasing stability of the political and economic landscape means I am cautiously optimistic for the UK economy over the next twelve months. However, we are always preparing for a different outcome; after all, lending is cyclical. As Chief Risk Officer, part of my role is to help ensure your portfolio contains businesses with the resilience to continue providing positive returns even if economic conditions worsen.
To achieve this we regularly carry out stress testing. This involves taking an adverse scenario modelled by the Prudential Regulation Authority (and used by all major UK banks in their own testing) and applying it to the projected returns of loans being taken out today. Doing this allows us to simulate what could happen to these returns in a potential downturn situation. While it’s important to stress the nature of modelling means these projected returns are estimates, and are the returns we expect to deliver once all loans have been repaid and recoveries received, in this scenario we would expect them to remain positive:
2019 Funding Circle stress testSource: Funding Circle stress test 2019
Providing you with the foundations to help the economy grow
There has rarely been a more important time to be lending to the UK’s small businesses. In the past decade the number of SMEs has grown by more than 1 million.** Despite this, outstanding lending from UK banks to SMEs is 15% lower than it was in 2011:
Outstanding bank lending to UK small businesses (£m)
Source: Bank of England
This highlights the difference your lending is making; helping businesses create jobs and invest in their local communities. Continuing to carefully monitor the wider environment, making timely and prudent adjustments where necessary, will allow you to help the economy grow while earning stable and attractive returns.
We hope you have found this information useful. If you have any questions, please don’t hesitate to get in touch, and remember by lending to businesses your capital is at risk. Not covered by the Financial Services Compensation Scheme.
Jerome Le Luel
*Projected returns as of 31st December 2019. The projected annualised return shows the return, after fees and bad debt, that loans are currently estimated to achieve. Loans are shown by the year they were taken out. The return is calculated by combining the actual annualised return received to date, and our latest return estimates, including expected recoveries, for the remaining term of loans that have not yet been fully repaid. Past performance is not a guarantee of future returns and by lending to businesses your capital is at risk.
**Source: UK SME numbers in 2010 and 2019
This material contains certain tables and other statistical analyses that have been prepared by Funding Circle. Numerous assumptions have been used in preparing this statistical information, which may or may not be reflected in the material. The statistical information should not be construed as legal, tax, investment, financial, or accounting advice. The Information is provided as of the dates shown and is subject to updating and revision, and may change materially without notice. Subject to applicable regulations, no person is under any obligation to update or revise the information. The information may contain various forward-looking statements, which are statements that are not historical facts and that reflect Funding Circle’s beliefs and expectations with respect to future events and financial and operational performance. These forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other factors, which may be beyond the control of Funding Circle and which may cause actual results or performance to differ materially from those expressed or implied from such forward-looking statements. Nothing contained within the information is or should be relied upon as a warranty, promise, or representation, express or implied, as to the future performance of any loans. Any historical information contained in this statistical information is not indicative of future performance.