Default risk : what if the borrower doesn’t pay ?

The #1 risk when investing in loans

A borrower who doesn’t reimburse the loans is obviously the greatest risk when investing in loans. Unfortunately, individual borrowers may be unable to reimburse their loans, real-estate projects may fail, and businesses may go bankrupt. Overall, all loans kinds are likely to default. In this article, we’ll examine the possible outcomes, based on real-life situations.

Loans covered by a buyback guarantee

Most P2P lending platforms offer loans covered by a buyback guarantee A buyback guarantee is a guarantee provided by the platform or a loan originator. If repayment of a loan is delayed by more than a given delay (usually 30 or 60 days), the platform or loan originator will buy back the loan. The guarantee may cover only part of the capital, or in a much more interesting case, both the capital and accrued interests. As the conditions vary from one platform to another, it’s very important to check this point.. If the investor is late, the investor is reimbursed the principal and accrued interests after a given delay.

This guarantee is applied automatically; once a borrower stops reimbursing, after the delay expires, the loan is automatically bought back by the originator.

The delay varies from one platform to another. Most use a 60 days dela, but it may be shorter.

Here are the buyback trigger delays and coverage for several platforms, as of April 2021. These platforms offer loans covered by a guarantee which covers both principal and accrued interest :

PlatformBuyback delaySource
Afranga60 daysAfranga FAQ
Bondster30 days or 60 daysBondster FAQ
Esketit60 daysEsketit FAQ
Lendermarket60 daysLendermarket FAQ
Mintos60 daysMintos FAQ
Moncera30 daysMoncera FAQ
PeerBerry60 daysPeerBerry FAQ
Robocash30 daysRobocash FAQ
Swaper30 daysSwaper FAQ
ViaInvest60 daysViaInvest FAQ

One of the consequences of the buyback guarantee is that new portfolios will often have a performance lower than expected during the first three months or so. Indeed, defaulted loans won’t yield any interest until the buyback guarantee kicks in. It will result in a slowly increasing performance.

Please note that several of these platforms (such as Iuvo or Mintos) also offer unsecured loans. Don’t forget to verify that the loan you want to invest in is protected by a buyback guarantee, which is usually indicated by a shield icon.

Iuvo‘s buyback guarantee is more restrictive. Indeed, it covers only the principal. This means that in the worst case, you won’t lose invested money… but won’t make money either.

However, even if the loan is secured by a buyback guarantee, it’s possible for the investor to take a loss. Indeed, it’s crucial to understand that the buyback guarantee is actually provided by the loan originator, not the platform. As a result, the guarantee is only as solid as the loan originator itself !

Unfortunately, many Mintos investors have learned this lesson the hard way, after losing part of their invested capital.

Mintos' defaulted loan originators

Mintos is a huge loans marketplace; they onboarded many loan originators, and not of them are equally reliable.

As a result, several of them found themselves in financial troubles; as many as seven already defaulted, which has lead to losses for investors.

Recovery status of Mintos' defaulted loan originators as of April 2021

I strongly recommend reading our article dedicated to Mintos loan originators, which covers this topic in depth.

Other platforms than Mintos may also feature sub-standard originators. For example, Aforti – which defaulted in August 2019 – was also present on Viventor. Even Iuvo ran in troubles with two originators, in spite of the stringent onboarding process.

On the other hand, until now, all loan originators present at PeerBerry proved to be reliable.

In order to acknowledge the fact that loan originators may fail to enforce the buyback guarantee, several platforms – such as Mintos and Esketit now call it buyback obligation.

Partially secured loans : Omaraha's warranty fund

Omaraha guarantees that if the borrower defaults, 60% of the remaining principal will be reimbursed to the investor. As I’m updating this article in August 2021, the amount available in the warranty fund has climbed to more than € 390,000.

The reimbursed amount used to be higher : between 60% and 80%, depending on the current level of the warranty fund. However, in Spring 2020, the uncertainties caused by the Covid-19 epidemics lead the platform to lower the compensation for defaulted loans. As a consequence, for several months, only 55% of the remaining capital was reimbursed. As the situation improved, this percentage was increased to 60% in early July 2020.

This fund is paid for by borrowers, as Omaraha collects 3% from loan amount. This will work as long as there are new borrowers, and if the default rate stays stable.

Overall I was compensated 70% of the total defaulted loans amount.

Happy endings : EstateGuru's recovered loans

Unlike most individual loans, EstateGuru‘s real-estate loans aren’t covered by a buyback guarantee. In spite of the rigorous project selection, the borrower may fail to make a repayment. It happened first for the project named Toome avenue development.

The borrower was supposed to repay the principal on November, 3rd 2017 but didn’t. One month later, on November 14th, 2017, EstateGuru started the process of selling the collateral. And one week later, on November 21st, 2017, the loan was repaid to investors, including interest, overdue charge and indemnity.

EstateGuru featured a short blog post on the collateral’s sale.

Many more defaulted loans were recovered throughout 2019 and 2020. As of August 2021, there were 54 of them (out of 144 defaulted projects); their average performance reached 10%. The length of the recovery process was very variable; it averaged 8 months but could take up to one year.

These happy endings are of course not guaranteed; however they show that a borrower’s default doesn’t always lead to a loss for investors, even if the loan didn’t come with a buyback guarantee. It all depends on the platform’s criterion for selecting projects, and on the efficiency of the recovery process – two domains where EstateGuru especially excels -.

EstateGuru’s blog also features an interesting post on how the platforms handle borrower’s default.

Capital loss, delays and uncertainty : CrowdEstate's defaulted projects

In the case of CrowdEstate‘s Kevade-9 project, the borrower didn’t even make its first interest payment (!) on March 20, 2017. Unfortunately for the investors, the enforcement proceedings seem to take forever.

While the Kevade-9 project’s page featured many updates, they may have left many investors frustrated. Indeed, most of them didn’t contain much actual information.

The extremely long list of mostly pointless updates regarding Kevade-9's recovery process

In February 2021, the recovery process was finally completed. The final annualized return was a meager 2.68%. CrowdEstate published a detailed blog post on the troubles the platform faced during the recovery process.

Overall, when it comes to completed recoveries, CrowdEstate’s track record isn’t exactly bright. Indeed, if investors at EstateGuru mostly suffered no capital loss after projects defaulted, it’s unfortunately not the case at CrowdEstate. Browsing the exited projects list reveals at least two opportunities with negative actual returns. The internal rate of return for Metsa Tee 31/33/35 ended up as -25%. Even worse, investors in the Estera Development Holding project had to take a huge loss, with an actual interest rate of -64% !

The long way to profits : Bondora's recovery process

Month after month, I used to report decreasing returns from my Bondora portfolio. The main culprit was a high default rate, coupled with a low recovery rate.

I finally gave up all hope to reach decent returns on this portfolio and converted it to Bondora’s Go & Grow, which is supposed to return 6.75% annually.

As concerns regarding the quality of Bondora’s overall portfolio grew, I decided the low Go & Grow returns weren’t worth the risk and liquidated it, closing my Bondora account for good.

How to protect yourself against a borrower default

For P2P loans, losses can be prevented by focusing on reliable loan originators. This will ensure that the buyback guarantee isn’t only a paper shield !

Investors who don’t want the hassle of choosing among Mintos‘ 70 originators or Viventor‘s 20 originators can now invest through platforms offering loans from a single lending group. Indeed, several financially solid loan originators have created their own platform in order to fund their loans.

For example, Robocash platform provides only loans from Robocah Group, Afranga is used by StikCredit to fund their loans portfolio, and Moncera lists Placet Group loans. These three large financial groups have an excellent track record and have been consistently profitable for years. They’re a great way to safely invest in loans with double-digit interest rates.

When investing in real-estate or business loans, it’s important to pay attention to the platform’s track record first. Then, selecting projects combining a low LTV with a 1st-rank mortgage will ensure that most or all of the invested capital is recovered in case of a default.

2 thoughts on “Default risk : what if the borrower doesn’t pay ?”

  1. Hi, regarding Mintos, it is important to know that though the principal is covered, not all loan originators pay interest on delayed payments or similar, here’s a message from Mintos about that:
    “Some loan originators pay Interest income on delayed payments, some pay Penalty income. As well you need to take into account the grace period, each loan originator has defined its own grace period.
    Please find all information here – https://www.mintos.com/en/loan-originators/#details

    That is important since sometimes the amount of delayed payments can be significant, hindering the overall return rate.

    Reply

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