By Roger Baird on Monday 1 July 2019
In the first in a series of interviews with the credit leaders of the alternative lending market, Ratesetter’s Michael Hoare explains why he made changes to the way the group’s provision fund is calculated.
No one drinks sparkling water at Ratesetter’s nondescript City of London head office - just still - which fits in with the sober image the peer-to-peer lender is keen to portray.
A lean Michael Hoare, the firm's chief credit officer, bounds into a bright meeting room a stone’s throw from the Bank of England keen to explain that the group, which has lent £3bn since it was founded nine years ago, is right on track.
Hoare changed how the business calculates outflows from its provision fund earlier this month, but is keen to assure anyone who will listen that there is nothing here to frighten the horses.
The provision fund is calculated on a loan-by-loan scorecard-based approach, with more detailed analysis carried out on loans that are more than nine months old - the old method, grouped consumer loans by risk, term, channel and origination to estimate outflows, such as missed payments and defaults.
Better view of losses
"The amount in the provision fund hasn't changed," says Hoare. "What has changed is the way we calculated expected outflows. The provision fund is our view of expected losses every month.”
He adds: "Under our old calculations it would take about six to nine months to get clear data on a set of loans. But the new set of scorecards should shorten this period by several months. It will tell us things like how many first payments were missed - and whether these payments made up later.
“It will bring in news earlier, and should be more accurate. We looked around at methods other financial service firms use, and this is what the best people are using."
It took Hoare and his 24-strong credit team - the engine room of a lender - a year of testing before they felt comfortable with the new system.
Analysts at investment bank Goodbody back the move: "Such further enhancements to Ratesetter's risk management processes are a welcome development as the company looks to differentiate itself from other players in this evolving segment of the credit market."
These firms were formed in the aftermath of the financial crisis in 2008 and cater to consumers who want higher service levels from lenders, and small firms who found banks pulling back from small business lending, fearing defaults. Peer-to-peer ventures also appeal to investors seeking interest rates of around 5 per cent, over the UK base rate of 0.75 per cent, which has only risen once in a decade.
This trio of firms account for some three-quarters of all the loans in this market. Ratesetter, run by founder and chief executive Rhydian Lewis, has an £850m loanbook. This breaks down into £650m of consumer loans, £150m of secured property loans and £50m of other loans, mainly secured motor loans and unsecured commercial debt.
The group consumer loans are typically around £8,000 and last between one year and 60 months.
"The loans we write tend to be towards the end of that range, lasting around four years," says Hoare.
An average property loan is between £1m and £1.5m, and lasts between 12 to 18 months.
"We tend to fund residential developments," says Hoare. "A conversion of an office building into flats, or a new build of a group of three or four houses."
Hoare joined Ratesetter in December 2016 as head of risk analytics & retail credit before promotion to his current post last January. He is on the group’s executive committee and reports directly to Lewis. Prior to that, he spent just under two-and-a-half years at US payments provider PayPal, where he was chief credit officer for Europe. Before that he spent almost a decade at credit card business Capital One, leaving in 2014 as head of third party marketing and product development.
Ratesetter is not seeing much sign of a Brexit slowdown, if its property business is anything to go by. Its property loanbook has jumped by £50m in the last 12 months, although its property unit was only set up set over two years ago.
Hoare says: "I don't know when the next recession will come, and nor does anybody else. Some developers talk about a pause in investment, but that may be no bad thing.
"For consumers Brexit has to mean something real. That may be jobs drying up, or tailbacks at ports. But unless that happens people keeping on going."
However, many see the next downturn, whenever it comes, as a crucial test for these lenders to see how they cope with defaults on repayments that could make or break them.
But the group has already been through a test of its own. Three years ago RateSetter used its own capital to buy a failing advertising and motor finance business to prevent a default hitting investors. Such tactics have been criticised by regulator Financial Conduct Authority (FCA) for masking the true performance of loans.
The group left the industry’s trade body, the Peer-to-Peer Finance Association, which it helped found, as a result of the scandal.
The lender absorbed the motor business and closed the ad firm, but the effort sent the business into the red over the following two years.
Hoare, who was on the consumer side of the business at the time said: “It was a tough time. But we learned from our mistakes and moved on."
Under-fire asset manager Neil Woodford, who is being probed by the FCA after suspending his fund flagship fund earlier this month, owns just under 2 per cent of the peer-to-peer lender in another fund. Ratesetter will make no comment about Woodford.
In the year to the end of last March the business reported losses of £26.7m, on revenues which jumped 47 per cent to £34.7m. The business said its bottom line was affected by a £13.5m writedown because of the two firms it acquired. Ratesetter points out that it was profitable in 2014 and 2015 prior to the scandal.
However, most peer-to-peer lenders are loss-making and are racing to add customers and hand out loans to boost scale, which they later hope to turn into profits. Although these firms continue to attract billions from investors who believe this wave of companies can emulate Big Tech giants such as Facebook and Google.
Ratesetter raised £15m from investors to fund the business last year.
It has also seen its rival Funding Circle, also founded in 2010, float in London last October, valuing the firm at £1.5bn, although it has consistently lagged behind its 440p stock price, with the market viewing its debut as overpriced.
Ratesetter has always said that it sees a public float as an option, without setting out a timetable.
In the meantime, the group depends on Hoare to keep underwriting loans to gain scale, while making sure it walks the right side of the fine line between competitive pricing and prudence.
Ratesetter’s Hoare will be drinking tap water for some time to come.