Are loans a good investment?
Maya Fisher-French looks at the pros and cons of peer-to-peer lending
Last month, we wrote about the growing global phenomenon of peer-to-peer social lending, which links borrowers and lenders directly, bypassing banks and their fees. RainFin, which was the first peer-to-peer online lending platform in South Africa, announced recently that after being in the market for two years, it is listing about 18 new loans at a total loan value of R400 000 for investors to bid on every day.
This impressive growth caught the attention of international heavyweight Barclays Africa, which acquired 49% of RainFin’s business in March 2014 and is now an active lender in the market.
Peer-to-peer lending is a similar concept to crowdsourcing, but instead of a business proposal, a borrower lists needs for a personal loan and investors decide if they want to commit funds based on a specific return rate. In the US, peer-to-peer markets will facilitate roughly $5 billion (R78 billion) this year, but at less than 40% of the operating costs per loan granted compared with traditional banks, according to Sean Emery, CEO of RainFin.
It is not, however, a solution for borrowers with poor credit records. Although RainFin has a registrant rate of 350 customers per day, representing an average R7 500 000 in loan value, less than 10% of these applications pass screening after undergoing a detailed moderation, scoring and affordability assessment. Is it an attractive offering for investors? Peer-to-peer lending models are certainly a costeffective way for borrowers with good credit records to access finance, but are they paying sufficiently high enough returns for individuals to take the risk in investing in these loans?
RainFin says it created the business to allow investors to receive returns comparative or better than RSA Retail Savings Bonds. Emery said that given its excellent management of impairments (nonpaying loans), the worst-case scenario for investors with significant impairment would bring their returns back to levels compared to that of retail bonds.
An investor needs to keep in mind that when investing in a bank account or an RSA Retail Savings Bond, the risks are significantly lower as you are not exposed to just one borrower who may default. Peer-topeer lending increases that risk.
Emery counters that peer-to-peer lending in itself is not a high-risk category, although the individual loans or assets within peer-to-peer deals could be high risk.
RainFin grades the various loan applications according to a risk profile, and investors can decide what level of risk and return they wish to take. The higher the risk of the loan defaulting, the higher the potential return to the investor – so the risk is highly dependent on the investor and the choices they make on the platform.
As an investor, you need to understand the risk implications of opting for higher returns. For example, an investor in a grade A risk profile, with a potential default rate of 0.41%, would receive a return of 10% over the period of the loan, while an investor in a higher-risk grade C loan, with a default rate of 6.6%, would receive a 20% return over the period of the loan.
It is important to understand the nature of the loan repayment, which is monthly – therefore, an investor receives a monthly income, which includes a portion of the capital invested as well as interest earned. As the interest is charged on a reducing balance, one cannot make a direct comparison with a normal fixed deposit – the actual interest rate received is not a yearly rate. The investor will receive a detailed repayment schedule to enable him/her to make informed decisions when investing in a specific loan.
For example, if you invested R10 000 in a grade A loan with a 10% return over two years, you would receive R461 a month, or R11 110.40 total return of capital and interest – that is a return of 11% over two years.
These are not particularly high returns and one would need to take increased risk to receive returns above what the market currently offers.
There is, however, the aspect of social sharing – research and experience have shown that people prefer to borrow and lend to their community directly rather than using a bank, which is often seen as an unfavourable “middle man” that limits access to funds and charges excessive fees.
For investors who have an appetite for risk and can afford to experience some loss or reduction in return, the higher-risk loans could be an interesting option. This is also an option for an investor who would like a similar return to a fixed deposit, but prefers the concept of social sharing and supporting the growth of peer-to-peer lending as an alternative to banks.
WHO CAN BORROW?
Must be a South African citizen Must be at least 18 years old Minimum Delphi score of 600 from Experian (credit bureau) Debt-to-income ratio of 60%, including mortgage At least two current open credit accounts reporting consumer behaviour Five or less account enquiries in the past three months Minimum credit history of 24 months