Hey, Everyone!

In this video, we will review investments on Peer to peer marketplace platforms, how they work, where this industry going, and how to invest. 

You might have a question why do I need to know that? 

The answer is pretty simple, peer-to-peer marketplaces offer fixed-income investments with approx 10% returns with the possibility to build diversified investment portfolios with great automation levels which makes it basically ETF for loan investing and an interesting investment tool.

Let’s discuss how this industry works and why it emerged in the first place. 

Let’s say there is a microfinance company in Spain that issues loans to underbanked private persons. At some point, the company has issued all money in loans and it needs more to issue new Loans.

Waiting for loan repayments would be very long, and getting a loan from the bank is hard, given that banks do not want to finance this industry since they are basically competitors and the company is not big enough to issue bonds. 

So the company started to look at how to raise funds in other ways and they understood that they have assets -a loan portfolio. 

Part of the loan portfolio could be sold to retail investors, to raise capital to issue new loans, and because microfinance companies have invested in borrower scoring, and acquisition and they continue to manage loans they keep a share of future received interest to themselves, for example, if loan issued with rate 20% you invest will get 10%.

It is not something unique, a similar practice was already commonly used by other credit organizations and this is basically a form of debt securities like mortgage back securities, etc. 

But there was no platform where to sell such investment products since you will not go to NASDQ to sell a 100 EUR loan and that is why peer-to-peer marketplace platforms were created. 

But there is one complication that makes this product even more interesting and the name of this complication is “buy back guarantee”. 

“buy back guarantee” - is basically insurance issued by a microfinance company, if the borrower delayed payments for more than certain days microfinance company buys back the loan from the investor, so investors do not lose money.

This thing not only makes loans more secure but also changes the Investment approach when investing. 

If there a buyback guarantee is applied business logic looks like this: 

You have a loan issued to a microfinance company and this loan repayment is synchronized with a loan issued to the end borrower and secured with claims toward the end borrower. So when the end borrower repays the loan, a microfinance company repays the loan to you, if the end borrower does not repay the loan on time, the Microfinance company repays you money under a buyback guarantee after certain days, and if the microfinance company cannot repay under a buyback guarantee, it goes bankrupt and some administrator will be appointed and he will try to get money from end borrower - which most likely will be done by selling the whole portfolio to some debt collection company for 20-40% of nominal and money repaid to you. 

So long sorry short - when investing in Peer to peer marketplaces your key risk point is the microfinance company and before investing you have to make sure that the microfinance company will be able to repay the money under a buyback guarantee. 

And here we have a few issues. 

So, how to invest through peer-to-peer marketplaces! 

To understand the risk level you need to evaluate a Microfinance company's financial standing and it is not that easy. 

Microfinance companies from a risk perspective are like Banks and Insurance companies, meaning the main risk is not visible from their profit loss statement and balance sheet alone it is hidden in their loan portfolios.

I will try not to get too technical but: 

Microfinance companies have two main risks - 

Profitability  - meaning they cannot efficiently sell the product or they cannot reach sales volumes to cover fixed costs etc, but you will be able to understand it from the profit loss statement.

The second risk is loan portfolio quality - I know I might sound like captain obvious but you must understand how significant this risk is!

If one loan is not repaid, the company will need to use the profit from several good loans to cover this loss and this is a lot. Just think about it if a company issue 1000 EUR for a month and it is not repaid how many good loans do they have to issue to cover it? If the interest rate is 100% then at least 12. 

The only indicator of portfolio quality in the Profit loss statement and balance sheet is the so-called provisions you will find it in the profit loss statement and it shows an estimated loss from bad loans.

Provisions are calculated as a % of the part of the loan portfolio for example the sum of - 50% of loans overdue more than 30 days, 100% for loans overdue more than 180 days, and so on. 

This indicator is usually reviewed in correlation with the portfolio and in dynamic. If last year's provisions were for example 10% of the portfolio and this year 20% we know that the company is sick. 

It is important to check the provisions and how they correlate with the portfolio but it might be already too late, therefore more important to understand if the company has symptoms and might become sick and it is hard to do based on provisions alone. 

To identify symptoms you should review detailed portfolio statistics, non-performing loan statistics, so-called vintage ageing statistics, and so on, but as I know none of the platforms provides this data about microfinance companies.

If I am wrong please, let me know in the comments and please go to the Crowdinform platform list and give that platform 5 stars in transparency, they deserve it. 

So what to do if we do not have this data? 

First of all, I would say it is ok that this data is not public since it is quite sensitive, and even if it were available only a few of us would understand it. 

Therefore we need to rely on a platform, that platform is performing microfinance company analysis and presenting results to investors correctly and transparently. 

But we need to remain skeptical, especially given the fact that a number of platforms are owned by microfinance companies which products they are selling and there is a risk of interest conflict. 

Here are a few things that I  find worth checking: 

• Monitor provisions/portfolio ratio changes and does the platform reflect these changes accordingly in rating, meaning if the proportion of provisions grooving but is not explained or reflected in platform rating/review it is a bad sign. 
• Bigger microfinance companies, especially those who issued bonds, have external ratings, it is good to check how they correlate with platform ratings, if the deviation is huge you kinda could make assumptions about other ratings as well. 
• Monitor your loan portfolio based on overdue days, yes your loan is just a fraction of companies total portfolio and it does not give a full representation of what is happening, but still, you can notice a few red flags. 

If you find something suspicious ask the platform for an explanation, it is the platform's main task to provide you with the necessary information so you understand the risk. 

It also would be great if you share your findings with others on the Crowdinform platform comment section or another channel. By exchanging information we will be able to avoid fraudulent activity and get a better understanding of risk. 

To sum up  - a key challenge is to understand the risk of the microfinance company before investing and to do so you need to find a platform that can provide you with a good transparent risk evaluation and wide microfinance company offering. 

Let’s discuss recent events and what they could mean for the industry

Last year's main event in peer to peer marketplace industry was that the first platforms started to operate under a regulated regime in Latvia.

If you are new to this industry you might think why licensing in Latvia is important. Latvia is home to a number of the biggest players so Latvia is pretty much the benchmark for the industry. 

Small remark: Europen crowdfunding service providers regulation is not applied to peer-to-peer marketplaces. 

So, what does regulation bring? 

To operate in Latvia platforms have to obtain an Investment brokerage firm license which means that platforms are now regulated and overseen by financial authorities, which is a great thing, since control and rules are there things that this industry is lacking. 

There are also capital requirements and if I am not mistaken if the platform has a secondary market ( a tool that allows you to sell your portfolio to other investors) capital should be at least 750 thousand EUR and if they do not offer a secondary market then 150 TEUR, which is another sign of security if someone invests such money in a business they will make it legit. 

The next big thing is how data is now presented, if previously you got financials and some presentation about a Microfinance company now they publish a prospectus and Key information sheet which in detail describes, the company, its operational and legal model, approach towards risk/ scoring processes,  also different scenarios what happens if borrowers don't pay and many more and so on. 

I think it is a huge step towards a transparent and more secure market. 

So wats next?

I do not have a crystal ball, but we could make some analogies with similar industries. There is a trend that when alternative investment companies that focus on retail investors grow big they start looking for cheaper sources for investments which means shifting to institutional money.

The largest USA crowdlending platform Lending Club decided to become a bank and raise funds on the intrabank market.  Several peer-to-peer platforms in the UK decided to shift to institutional investors only or also become a bank. 

Most of the Latvian-regulated platforms are relatively big in size so they have decent offerings for institutional investors, their product is now a legit,  investment product registered in the depositary, so they have all preconditions to go for big money. 

What does it mean for retail investors? First of all, I do not think it will happen overnight, but due to increased demand, rates will go down + plus regulated platforms will focus more on quality than quantity in supply so it will also drop and it will decrease rates even more. 

I believe we also should not expect a lot of cool new features for retail investors since the platform will try to improve the UX of big players. But institutional investors will demand more transparency from which all will win.  B

The bottom line is, I would say we will see lower risk and cost products in a while. 

Another thing that I wish platforms would introduce is an optional buyback guarantee. I mean when they started, it was an innovative product so they had to offer as much security as possible, but now when it is a legit financial instrument - I want to decide do I want it or not, which will allow me to make bigger returns for higher risk.

Some peer-to-peer platforms offer insurance as an optional feature, so why can't we have it on marketplaces?  

Plus if I take end borrower risk, evaluating end borrower risk will be easier than microfinance companies if borrower ratings will be presented in a proper manner. 

It is time to wrap up, so what we learn today. 

Peer-to-peer marketplaces offer great investment products and the industry becomes more secure and transparent which is great news. 

There is still a way for improvement and we can make an investment in peer-to-peer marketplaces more secure by working together. Please share your findings and concerts about platforms and microfinance companies with others and rate and leave a review on the Crowdinform platform list.

It is all for now!

Have a good day and wish you successful investing.