By Gareth Vaughan
New Zealand's second operational peer-to-peer (P2P) lender Squirrel Money isn't roaring out of the gate like rival Harmoney did because it's not using funding from banks or institutional investors.
Managing director John Bolton told interest.co.nz in a Double Shot interview the pace of Squirrel Money's growth will be dictated by those who invest in loans through the firm's website.
"One of the key things for us is that we have intentionally not put a bank or investment bankers behind the platform so that all of the funds that are raised have to come from retail investors," Bolton says.
"That means that you've got to be a bit careful and you're going to be a lot slower in how you lend out. The way I view it is it's going to be a bit of a growth curve. It's going to be slow to start with, probably for the first six to nine months, but we'll see it steadily increase as investors get more comfortable with the way that we're doing things."
"Our growth rate's going to be very much dictated by the investors. The more money that's invested through the platform, the more we can increase the amount that's lent out to borrowers," adds Bolton.
In August, after Squirrel received its licence from the Financial Markets Authority, Bolton told interest.co.nz he'd be "more than happy" if about $50 million of lending is facilitated over the firm's first two years.
That contrasts with Harmoney, which with the help of funding from shareholder Heartland Bank and institutional investors, lent more than $100 million in its first year. Harmoney has also secured $200 million of institutional funding from the British based Australian market. And in the more mature US market, P2P lenders are bundling and selling off loans through securitisations.
Squirrel launched at the start of November. Speaking last week, Bolton said it was poised to pass $600,000 of loans facilitated, with an average size of about $20,000 and the majority borrowed for five years. Although it offers both secured and unsecured lending, Bolton says unsecured loans are dominant thus far.
Much of the lending arranged early on has been A and B risk grades, with hardly anything below C grade.
"Our intention's to keep it that way. We really want to stay in that bank quality end of the market," says Bolton.
'No shortage of borrowers'
Squirrel, he says, is rejecting between 70% and 80% of loan applications. In terms of the loans it is facilitating, most are for car purchases, debt consolidation and general "tidying stuff up for people."
"There's no shortage of borrowers out there. What we've learned very early on is that we can dial that up or down at will. But obviously what we want to do is not have too many borrowers on the platform because there's nothing worse than sitting there and not having a loan funded for an extended period of time," says Bolton.
He describes initial investors as "early adopters" who are investing small amounts of money to see how it goes.
"Their first interest payments are going to start to come out in the next week or two. Then gradually from there I think you'll start to see a bit more confidence and they'll see how it's working and how it's flowing."
Bolton says there's a bit of a mis-match between borrowers and investors early on with the vast majority of borrowers wanting five year terms and investors typically wanting two to three years.
"What we've been educating investors on is that these investments repay like a loan. So you've actually got principal coming back from day one, and 32% of the principal on these loans is actually getting repaid in the first two years," says Bolton.
"So although it's a five year investment horizon the reality is at the end of five years all of your capital has been repaid."
'As far as rates are concerned, the (investors') interest rate at five years at the moment is hovering around 8.5%. with those shorter terms we think they'll settle down around 7.5% maybe 8%, after money is being passed up to the investor fund to protect investors from credit losses," Bolton says.
Borrowers are paying between 10.5% and 13.5%. Borrowers' interest rates are determined by a contestable, auction type bidding process meaning the more investors that join in an auction, the lower the rates on offer are.
"We're not really getting it below 10.5% at the moment because there's not enough investors in the platform yet for competition to start to lower those funding rates," Bolton says.
Investors don't have to assess the risk of 'a whole heap' of loans
Rather than the Harmoney style fractionalisation that sees investors spread risk by spreading their money around numerous borrowers in small sums, Squirrel has a reserve fund, Loan Shield. This, Bolton says, works the same way as how a bank manages its credit risk.
He maintains an advantage of the reserve fund approach over fractionalisation is that investors don't need to spend time looking at "a whole heap of loans" assessing the risk of each loan.
"Our approach... is to pass the credit risk up to a mechanism that essentially diversifies it across the entire portfolio, which is what the reserve fund does, and therefore pass the benefit of that diversification straight through to the investors in totality."
"Roughly about 2.5% absolute, which is about quarter of the actual interest payment by the borrower, is passed up to the reserve fund. So the reserve fund will grow over time," says Bolton. "If a borrower misses a payment the reserve fund pays it straight away through to the investor so that the investor gets their regular return."
"We're reserving at 4% of the total lending outstanding. Our expected credit losses run between 1.2% and 1.5%. So we're reserving at over two times what we expect in terms of credit losses."
In terms of fees, Squirrel's key fees see borrowers charged a flat $250 fee for an unsecured loan, and a $500 fee for a secured loan. Investors pay a platform margin of 2%.
The Commerce Commission is looking at how P2P lenders are covered by the fees provisions in the Credit Contracts and Consumer Finance Act (CCCFA). Harmoney recently dumped its platform fee for borrowers that ranged from between 2% and 6% of the loan amount, based on the loan's risk grade, and introduced a flat fee of $375. The third licensed and operational P2P lender, LendMe, is however sticking with fees for borrowers of between 1% and 7% of the sum borrowed, depending on a loan's risk grade.
(Meanwhile, a Diana Clement NZ Herald weekend article suggested some investors are unhappy with Harmoney "churning loans to double dip its commission." Clement quoted Garth Stanish, director of markets oversight at the Financial Markets Authority, saying, "We were not aware of this alleged business model where investors' loan documents are cancelled and then rewritten when borrowers borrow additional amounts through the platform.")
'A proposition that stacks up'
Bolton is confident the Commerce Commission won't have an issue with Squirrel's fees.
"We always took the approach that whatever we did would be compliant with CCCFA," he says. "But for us it was actually about making sure we had a proposition that stacked up in terms of where we felt peer-to-peer sat in the spectrum."
"At the end of the day you have to be delivering a better proposition into investors and borrowers than they can get elsewhere in the market (from other P2P lenders, banks, finance companies etc). So for us a low upfront fee for borrowers and really competitive interest rates was really a starting point for the entire platform."
Bolton, an ex-general manager at ANZ, is also managing director of mortgage broker Squirrel Mortgages. This far he says there's little cross over between Squirrel Mortgages' and Squirrel Money's customers.
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