The tricky balancing act of buyback guarantees
Buyback guarantees have been popular amongst European peer-to-peer lending platforms but with economic conditions expected to result in an increase in loan defaults, the offering might become more tricky.
Some platforms have already had issues with guarantors in the past. For example, Mintos suspended Capital Services loans in 2020 after the lender failed to transfer borrower repayments and the buyback price on time. An August update from Mintos said the current cases of default are being “worked out” .
On the buybacks, the group noted: “For the vast majority of cases, the buyback obligation works well, and investors receive back their funds for non-performing loans. It’s only when the issue spreads to the entire lending company that the buyback obligation cannot be exercised as planned. For example, Wowwo fulfilled its buyback obligation and loans that were 60 day past due from borrowers were bought back from investors. However, the situation changed when Wowwo stopped all payments towards investors on Mintos and is not honoring its obligation.”
Mintos did not respond to a request for comment.
At the end of 2020, Mintos rebranded its buyback guarantee offer making it clearer for investors who warned that the word “guarantee” was misleading.
Read more: Monethera suspends buybacks amid Estonian P2P concerns
In contrast, UK-based platforms have not tended to utilise buyback guarantees.
In fact, Rebuildingsociety is one of the only UK firms to offer this type of investor protection.
Chief executive Dan Rajkumar said the platform introduced it in 2019 as a risk mitigation structure as investors do not have access to the Financial Services Compensation Scheme. So far, it has worked very well, he said. For example, just a few weeks ago the system triggered a buyback for around £15,000, which was successful.
Rajkumar said some investors like the extra protection, while others like the extra returns they can make when they select the right businesses and can price the risk with a premium.
However, he is aware of the risks in the current market environment, which puts pressure on many businesses.
“It can be tricky to get the balance right of the risk and rewards,” he said. “What you’re effectively doing is subdividing risk and reward between the lenders and getting that subdivision correct is a delicate thing to do.
“I’m pleased that everyone who has used the buyback guarantee and bought has had the protection and terms and conditions so the performance of the protection is working as planned and nobody has lost any money.”
He said that on Rebuildingsociety, a guarantee can only be offered up to 40 per cent of the value of a lender’s portfolio and the platform holds collateral, just in case. The platform is now looking to increase the limit to 45 per cent following demand.
Read more: Rebuildingsociety launches buyback guarantee on secondary market
For now, the buyback guarantee has provided the intended protection and increased returns to lenders.
“That’s largely symptomatic of the fact that a lot of the lending we’ve arranged has performed,” Rajkumar said. “In a downwards market where it doesn’t perform, that puts an increased strain on guarantors, but they acknowledge that risk.”
But why haven’t other UK platforms offered buyback guarantees?
While it is difficult to pinpoint one reason, Rajkumar has an idea.
“I think it’s because it’s a peer-to-peer guarantee, arranged between the lenders using the secondary market that is facilitated by a platform,” he said. “I think in the UK some platforms went down the path of designing a provision fund to protect the investors but actually created an inefficiency in the model and there hasn’t been much innovation in the UK P2P market since the introduction of the regulations, which have seen more people leave the market than enter it.”
Neil Faulkner, chief executive and head of research at 4th Way, said there has been slightly greater usage of reserve funds in the UK instead.
“Sometimes in the UK there is first-loss coverage, where the platforms, or businesses closely linked to them, co-invest and lose their money first on any loan, which is effectively like investors getting a better loan-to-value,” he said.
The majority of UK-based providers don’t offer credit enhancements, which means more of the return goes to investors and they are easier to assess, Faulkner added. But they also don’t benefit from the advantages of buyback guarantees.
“Ultimately, it’s not whether a platform offers credit enhancements that matters most,” he said. “The most important aspect is whether they assess borrowers and their security correctly, and price interest rates sensibly. If they get that right, investors who diversify and have sensible investing strategies can expect to do just fine. If they don’t do that, even credit enhancements probably can’t save investors from problem loans.”