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 this second edition of our series, Jerome provides his view on the current macroeconomic climate in each of our markets, what this means for the businesses that investors lend to, and the actions we have taken to protect your interests.
Fair economic conditions, with some increasing uncertainty
In my last update, I discussed how the economies of the four countries where investors lend through Funding Circle have recovered since the last recession. Across the UK, US, Germany and the Netherlands, these conditions have largely remained in place.
However, over the past six months we have started to see some increasing signs of uncertainty. In the US, interest rate rises—and subsequent cuts—point to an indecisive approach from US central bankers. In the UK, there is increasing political and economic uncertainty around the possible consequences of Brexit. At the same time, rising trade and political tensions have heightened anxieties in export-oriented economies like Germany and the Netherlands, who sell more goods than they buy. Despite this, these economies are performing well, with unemployment and central bank interest rates still at historically low levels.
Maintaining attractive returns with a prudent approach
We update our projected returns every three months. For each group of loans, we combine the actual annualised return received to date, and our latest estimates for the remaining term of the loans that have not yet been repaid. Our most recent update shows returns remaining stable since our Q1 update.
Projected returns* after fees and bad debt, all markets
At Funding Circle, our team carefully monitor the macroeconomic environment and regularly update and adjust our credit models to reflect changing conditions, tightening when necessary. Over the past twelve months we have prudently adjusted our lending criteria to strengthen the resilience of the loanbook, which is well-positioned for any potential changes to the wider economy.
Projected returns after fees and bad debt, Q1-Q2 2019 loans
The above chart shows the loss coverage**—the amount bad debt would need to increase by before investors experience negative returns—of the loans being taken out in each of our markets this year. As an example, if businesses experienced conditions similar to those in 2008, our stress-testing shows investors could still expect to earn positive returns.
This approach should allow us to continue delivering attractive returns to investors across all our markets.
Brexit uncertainties notwithstanding, overall UK small business performance has remained stable. However, there is a small segment of the market which has been underperforming. I have previously discussed how a significant expansion in consumer borrowing since 2013 has led to an increase in the number of individuals being made insolvent. While you don’t lend to individuals through Funding Circle, this trend has had some knock-on effect on the insolvency rate of UK small businesses; the smallest of whom may be more reliant on lines of personal credit when managing their business cashflow.
UK small business and consumer insolvencies (Q1 2008 = 100)
The large majority of businesses you lend to are performing in line with expectations, however the worsening consumer credit environment has impacted a small population of loans in our higher risk bands. Our 2016 – 2018 cohorts were updated in April to reflect this.
Projected returns after fees and bad debt, UK
Last year we made a number of adjustments to our credit policies and risk models to significantly reduce investors’ exposure to this segment of businesses. While we have already seen some positive results, earlier this year we further tightened our lending criteria. We have also increased some of the interest rates paid by businesses. This will help protect returns during a period of increasing uncertainty and loans originated in 2019 are now expected to deliver net returns of 5% – 7%.
In the US, the economy has been performing well, with both small business and consumer insolvencies remaining significantly below pre-recession levels.
US small business and consumer insolvencies (Q1 2008=100)
While currently very healthy, we are mindful that the current business cycle has lasted for a record ten years. The ongoing trade issues with China could affect this, while the Federal Reserve has also started to cut interest rates. We have also started to see some wider business volatility, which has fed-through to the projected returns for loans taken out in recent years.
Projected returns after fees and bad debt, US
In light of this, we have strengthened the US loanbook ahead of any changes to the business cycle, by tightening our lending criteria and increasing the interest rates paid by businesses.
Both the German and Dutch economies continue to perform strongly, with the insolvency rate across both individuals and businesses continuing to fall.
DE/NL small business and consumer insolvencies (Q1 2008 = 100)
Rising global trade tensions have led to a slight reduction in business confidence, although levels remain well above those seen during the last recession.
DE small business and consumer confidence index
As a result, loan performance across both Germany and the Netherlands has remained strong, although we will continue to carefully monitor both markets for any sign of stress.
Projected returns after fees and bad debt, DE
Projected returns after fees and bad debt, NL
Making the right adjustments
As Chief Risk Officer, my role is to help you earn attractive returns throughout each stage of the economic cycle. Although we have seen some macro volatility in our markets, we believe we have made the right adjustments to maintain the resilience of the businesses you lend to.
The four markets we operate in are great places to lend to small businesses. Careful monitoring, intelligent use of data and prudent action should allow us to continue providing you with attractive returns.
We hope you have found this information useful. Please remember that by lending to businesses your capital is at risk.
*Projected returns as of June 30, 2019. The projected annualized 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 annualized 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.
**The loss coverage of any given group of loans is the gross yield—minus the 1% annual servicing fee—divided by the projected bad debt rate of those loans. It is a simple representation of how much bad debt would need to increase by before it is higher than the interest investors receive from those loans. As bad debt does not occur evenly over a loan’s term, the loss coverage assumes loans are held until they have been fully repaid and recoveries have been received. There are other factors that affect how loans might perform in an economic downturn, and the loss coverage should not be seen as a guarantee of performance. The loss coverage for each group of loans reflects that bad debt rates are projected as a range.
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.