Chief Risk Officer’s Update – December 2018

Jerome Le Luel joined Funding Circle as Global Chief Risk Officer three 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. 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. Their role is to help ensure you can earn attractive returns by deploying industry-leading risk management techniques and models.

In the first of a bi-annual series, Jerome will provide his view of what has been happening in the wider economy, and what this means for the businesses you lend to.

The economic environment has created favourable lending conditions

Investors lend through Funding Circle to small businesses in the UK, US, Germany and the Netherlands. Looking at these four economies in detail we can see that they have all recovered from the 2008 recession, with sustained growth in Gross Domestic Product (GDP) over the last four years:

1. GDP growth %, year on year

Source: Federal Reserve, ONS, OECD

In each of these markets, central banks have set historically low interest rates, making the cost of borrowing affordable and stimulating economic growth. Where interest rates have risen they have done so very gradually, to avoid triggering another recession:

2. Central bank interest rates

Source: Federal Reserve, BoE, ECB

This has resulted in strong levels of job creation and low unemployment rates:

3.Unemployment rate

Source: Federal Reserve, ONS, ECB OECD

This positive economic environment has created conditions that are highly favourable to lending. As a result, credit defaults for businesses have reduced significantly following the recession.

4. Small business insolvencies (Q1 2008 = 100)

Source: Paynet, Gov.UK, DESTATIS, CBS Statistics Netherlands

Across the US, Germany and the Netherlands consumer defaults are also at historic lows. However, the UK has seen an increase in the number of consumer insolvencies over the past two years:

5. Consumer insolvencies (Q1 2008 = 100)

Source: Federal Reserve, GOV.UK, DESTATIS, CBS Statistics Netherlands

This has been driven by a steady increase in consumer borrowing since 2013 as wages struggle to keep up with the cost of living. We haven’t seen this replicated in the UK small business space, as banks continue not to focus on small business lending. This can be seen below by the total outstanding stock of loans to small businesses, which is lower now than it was in 2011.

6. Outstanding loans to UK consumers and small businesses (£bn)

 
Source: BoE

However, the trends we have been seeing in the consumer space are having a knock-on effect on the overall insolvency rate of small businesses in the UK, which as we saw in graph 4, has risen slightly in recent months (although is still below pre-recession levels). For example some business owners—especially smaller ones—may be more reliant on personal credit cards than business bank overdrafts when managing the ongoing cash flow of their business.  

This trend looks to be isolated to the UK, with consumer and small business insolvency levels remaining low in the US, Germany and the Netherlands.

Loan performance has been strong

Investors lending through Funding Circle have continued to earn attractive, stable returns. Across our four markets, loans taken out since 2016 are projected to deliver returns of approximately 4 – 7% per year, after fees and bad debt.

Projected returns* after fees and bad debt, all markets

Source: Funding Circle

The consistency of these returns is reflected in recent lending commitments from some of the larger investors who lend through the platform. In addition to a new £150m funding facility from the British Business Bank (the UK government’s development bank), over the past few months two well-established institutions have committed to lend $1 billion and £1 billion to small businesses in our US and UK markets respectively.

US

We have seen consistent improvement in the performance of US loans since 2016. This has been driven by two key factors: an increase in the proportion of lower risk businesses accessing finance through the platform, and the increasing maturity of our risk models, now in their fourth generation in the US.

Projected returns after fees and bad debt, US


Source: Funding Circle

 

We have adjusted our pricing to reflect that base interest rates are rising faster in the US than our other markets, and loans originated in Q1-Q3 2018 are currently projected to earn investors 5.8% – 7.8% after fees and bad debt.

UK

Although the credit environment for small businesses remains strong, as mentioned the outlook for consumer credit in the UK has worsened in recent years. This has impacted a small population of loans in our higher risk bands who can be more susceptible to shifting trends in the consumer credit environment. These headwinds are reflected in the projected returns for our 2016 and 2017 cohorts, which are 5.4% – 6.3% and 5.2% – 6.2%.

Projected returns after fees and bad debt, UK

Source: Funding Circle

We regularly update and improve our assessment models, leveraging more than eight years of loan performance data, and we made adjustments in recent months to account for this. These include tightening some of our credit policies and deploying our latest risk model, incorporating data directly from an applying business’s bank. The loans that have been taken out following these adjustments are projected to deliver investors returns of 6% – 7% after fees and bad debt.

Germany

Since Funding Circle acquired a business in the German market towards the end of 2015, we have seen significant improvements in loan performance; supported by the implementation of learnings and best practices from our more developed markets.

 

Projected returns after fees and bad debt, Germany

Source: Funding Circle

Netherlands

We expanded into the Netherlands at the same time as Germany, and we have seen similar levels of improvement over the past few years. In both markets we have developed our in-house Collections and Recoveries capabilities, and are now seeing recovery rates at similar levels to the UK.

 

Projected returns after fees and bad debt, the Netherlands

Source: Funding Circle

This serves to highlight the self-improving nature of lending; the more businesses that access finance through lending platforms, the stronger and more predictive risk models become. This allows us to price loans with even more accuracy.

The outlook for the economic environment is encouraging

Across all of our markets we believe that conditions remain encouraging for small businesses. In the US the economy is on a strong trajectory, stimulated by recent tax measures that have provided incentives for businesses to make investments. Although the US economy may be closer to the end of the business cycle than the start, the fundamentals remain strong and the small business credit environment is likely to remain positive in the medium term.

In the UK trading conditions remain favourable, although Brexit is creating a degree of uncertainty. We can’t predict the outcome of negotiations between the UK and the European Union, however our stress modelling (see below) shows the UK loanbook is in a strong position to weather any potential economic fallout.

The economic recovery started later in Germany and the Netherlands, so there is likely to be further to run before the end of their business cycles. Both Germany and the Netherlands are export-oriented economies; they tend to sell more goods to other countries than they buy. This means there is the potential for some exposure to the rising political and international trade tension we have seen in recent years. However, overall we remain positive about the stability of the German and Dutch small business environment over the next few years.

We are confident returns will remain resilient through a recession

A deep understanding of credit risk, and first-hand experience of managing multi-billion pound lending portfolios—particularly through the 2008 recession—has taught me that although lending is cyclical, careful monitoring and a prudent approach can provide investors with attractive returns throughout every stage of the economic cycle. When downturns happen, defaults do increase. However, it’s important to remember the vast majority of borrowers should remain financially healthy.

At Funding Circle, we rigorously prepare for changes in economic conditions. Part of this is to regularly stress test the loans in each of our markets. To do this we take a base scenario**—the projected returns from loans being originated today—and using a bespoke stress testing model, apply a number of adverse scenarios recommended by each market’s central bank. This allows us to simulate what could happen to the projected returns established in our base scenario. Although every recession is different, the results show that even in severe economic conditions investors should still be expected to experience positive returns:

 

2018 Funding Circle stress test results

Source: Funding Circle Stress Test 2018.

These results assume that no action would be taken to mitigate losses in the event of a downturn. In reality, we carefully monitor loan performance for signs of stress. If there were signs that conditions were worsening, we would make adjustments to account for some of its effects: for example tightening our assessment process, or calibrating prices on new loans. These actions should mitigate some of the adverse impact on investors’ returns.

Although we can’t predict when and how the next recession will happen, my experience tells me that we are ready. We are originating resilient loans in all of our markets, and we have the right tools in place to mitigate economic stress if needed.

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.

Jerome Le Luel

*Projected returns as of 30th September 2018. 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.

**Base case scenario taken from projected returns of loans originated Dec 2018.

Disclaimer
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.

What is compound interest and how can it boost your earnings?

Whether you’re investing for your retirement, a new home or your children’s future, compound interest can help you reach your financial goals faster. It’s effect means that even small changes in what you put away each month can make a huge difference to your earnings over time. To help you understand how, we take a look at how it works and what it could mean for you.

What is compound interest?

Compound interest can help boost your earnings over time. Here is a basic example of how it works.

Say you have an investment of £10,000 and earn interest at 5% per year, your balance would go up as follows:

Year 1

Interest added = 5% of £10,000 = £500

Total balance = £10,500

Year 2

Interest added = 5% of £10,500 = £525

Total balance = £11,025

Year 3

Interest added = 5% of £11,025 = £551.25

Total balance = £11,576.25

You can see the amount of interest that gets added each year goes up, as you are effectively earning interest on your interest. This is what is meant by compound interest.

Regular contributions can help accelerate your earnings

Naturally, putting money aside each month means you’ll have more in your account. However, regular payments will also help you earn more interest. The more money there is in your account, the more interest it will gather, and the more compound interest you’ll earn on top of that.  

If you started with £10,000, here’s an example of what you could earn on the Balanced lending option with regular monthly payments:

Compound interest table

As you can see, the amount of interest you could earn goes up rapidly with bigger monthly payments. A simple way to make regular payments into your account is to set up a standing order. Find out how here.

Think long term for bigger returns

When you start to look long term, compound interest can help your earnings grow exponentially. The difference can be really quite remarkable. Here’s an example of what you could earn on the Balanced lending option if you started with £10,000 and added £100 each month: 


20-30 years may seem like a long time, but if you’re planning for your retirement or a nest egg for your children, it may be a realistic timeline. The sooner you start, the sooner you’ll start benefiting from your compound interest.The increases in what you could earn get bigger and bigger over time. This is all thanks to compound interest. By earning interest on your interest over many years, your earning potential rises dramatically. After 16 years you could have doubled your money. After 30 years, you could have more than tripled it.

Keep lending switched on

When you receive repayments from businesses, our lending tool will automatically lend them out again to other businesses. By keeping lending active, you’ll be able to gain even more from compound interest. All you have to do is keep lending switched on for your account. If you have lending paused, you can start lending again from the Lending settings page of your account.

To add funds to your account login here, or learn how to set up a standing order.

Enjoy lending!

These figures are estimates based on lending an initial £10,000 through the Balanced lending option, earning a return of 6% per year. They were calculated using a compound interest calculator. The projected return for the Balanced lending option is 6-7% per year after fees and bad debt, but before tax. Your actual return may be higher or lower. Please note, forecasts are not a reliable indicator of future performance and your capital is at risk.

This blog is a general summary, and should not replace financial advice tailored to your specific circumstances. Funding Circle is not authorised to, and does not, provide investment, tax, legal or regulatory advice. If you have any questions, please speak to your professional advisor or seek independent specialist advice.

 

How to earn a more stable return with diversification

We want to help you get the most from your account and earn attractive returns. One of the best ways to earn a more stable return is diversification. Check out our infographic to find out what diversification means and how it works, or read our summary below. 

Diversification

What is diversification?

Diversification is a way of spreading your risk. It’s basically a fancy word for saying “don’t put all your eggs in one basket”.

At Funding Circle, this means splitting your investment into lots of small pieces, then lending them out to different businesses.

Why is it important?

As an example, say you lent £2,000 all to just one business. If they were unable to repay their loan, you could lose all of your money in one go.

Instead, if you were to split your £2,000 across 200 businesses, you could then lend just £10 to each. Then if one or two of them couldn’t repay, you would only lose a small amount.

You would still have a great chance of earning a good return overall.

What do I need to do?

To help, we’ve made diversification easy. Our automatic tool will help you lend your money in small amounts to lots of different businesses.

We suggest lending £2,000 or more, as our lending tool will then spread your funds across at least 200 businesses, with no more than 0.5% going to each one. 93% of the investors who have diversified like this for at least a year have earned 4% or more.

To lend £2,000 or more and diversify your account today, simply login to your account.

Past performance is not a guarantee of future performance, and by lending to businesses your capital is at risk.

Enjoy lending

Unsecured loans vs secured loans and what is a personal guarantee?

Unsecured loans explained

Welcome to our new Explainer series, where we’ll be helping you understand common phrases in more detail. We want to help clear up any terms you’re not familiar with, so you can make informed decisions on which loan is right for you.

First up we’re taking a look at personal guarantees and the difference between secured loans and unsecured loans. Looking from a borrower’s point of view, below we outline what the terms mean in general. We’ll then go into more detail on what to expect at Funding Circle.

For the most part, secured and unsecured business loans are very similar (although property loans can differ). You get a lump sum, then pay it back in installments with added interest. The key difference comes if you are unable to pay off the loan:

Secured Loans

With a secured loan, you put forward something of value as a ‘security’. This could be property, land, equipment or other assets. If you stop repaying your loan the lender could take this asset and sell it to recover the unpaid amount. The loan is secured against the asset or assets chosen.

Unsecured Loans

With an unsecured loan, you do not put forward any assets as a security. That means you don’t have to give up your property, land, or other assets if you can’t make the repayments. The lender may ask instead for a personal guarantee, or simply trust you are creditworthy enough to repay the loan.

What is a Personal Guarantee?

A personal guarantee is an agreement that the person(s) involved will cover the cost of the loan if the business is unable to repay it. Typically this is the Director(s) of the company. They become the guarantor of the loan, meaning their personal assets could be taken if the business fails or is otherwise unable to repay the loan.

Pros and cons

Unsecured loans are usually quicker to apply for as they require no valuation of assets. They are also a useful option if your business doesn’t have any high value assets that you can use as a security.

However, sometimes unsecured loans can have a higher interest rate as the lender is taking a greater risk. Being creditworthy enough to qualify can also be very difficult. Providing a personal guarantee can counter both these problems.

If, however, you would like to keep your personal finances completely separate, a secured loan may be your preferred option.

How does it work at Funding Circle?

At Funding Circle businesses borrow directly from our range of investors, including people, local councils and institutions. They provide all the capital for our loans, and if the loans they fund are not repaid, they could lose part or all of their investment.

So, to help us give investors greater peace of mind about the money they lend, we ask for a personal guarantee from company shareholders on almost all of our business loans.  

Unlike some other lenders, at Funding Circle the interest rate you have to pay on your loan will not be affected whether you choose to get a secured loan or an unsecured loan with a personal guarantee. For business loans our interest rate is determined by your risk band (although again property loans can differ). This is worked out using a number of factors such as your credit history, turnover and company finances.

All decisions regarding risk bands and the type of security required are taken by Funding Circle’s Credit Assessment team.

Looking for a secured or unsecured business loan?

You can check your eligibility for a business loan from Funding Circle in 30 seconds.