When is a Default on a P2P loan not a Default?

Last post: Jul 9, 2017

How to peer to peer lenders treat defaults? Very differently actually and the astute investor will need to be aware that each platform defines a default differently.

Defaults are the downside of investing in peer to peer (P2P) loans to SMEs. For the well diversified, they nibble away at income and for the foolhardy who over commit to a small number of borrowers they can result in heavy losses if it's not possible to recover the outstanding debt.

Although the percentage of bad loans is a key matrix for investors to consider when deciding where to place their funds, each P2P site has their own criteria for deciding when a loan should be defaulted – in some cases, they appear have no criteria at all!

Two companies at either extreme of the scale are Funding Circle and Lending Crowd.

For instance, if a business falls into administration then Funding Circle will notify investors that the loan is being defaulted even if all payments are up to date and the guarantor has set up a direct debit to continue to service the debt.

In this example, the loan would be allocated a status of Green on Funding Circle's Red/Amber/Green system of rating defaulted loans as a full recovery of capital would be anticipated. Red indicates that at least some losses are likely.

However on the Funding Circle investor's summary page, there is no way of listing only those loans where a loss is certain, all capital tied up in defaulted loan is subtracted from the profit total until funds are actually recovered. Capital tied up in loans that are not classed as defaulted is not deducted in this way.

The exact situation could be worked out by going through each individual loan in trouble but I have almost 60 of these (out of a total over 500). It is so much easier to just check my account's dashboard. At least I know my current annualised net figure of 7.7% is a worse than worst case amount although it does look eye-wateringly small next to the 14% gross return!

Conversely, over at Lending Crowd – where my dashboard tells me I am earning 9.2% – one of my borrowers had gone into administration 15 months before the loan was declared as a loss. The guarantor had been trying to sell a property to pay off the debt with no success. I have another loan to a business that went into administration 4 months ago. It is shown as being in arrears but hasn't been declared as a loss therefore the capital has not been deducted from my total holdings as displayed in the account summary.

Despite not reporting companies who are in trouble immediately as losses, Lending Crowd still pursue borrowers when payments are late. The differences in how bad loans are reported and when capital is subtracted from investor's totals do not necessarily indicate a laxness in how debt is recovered but the discrepancies make comparisons of P2P platforms via headline statistics impossible.

I am most surprised the FCA didn't introduce a standardisation of procedures as part of the requirement for being allowed to offer IFISAs.