Quick guide to Lending Works’ Reserve Fund
A fortnight ago, the former chairman of the now-defunct FSA, Lord Adair Turner, caused a stir when he stated (among other things) that “P2P platforms could be the source of huge losses over the next 5-10 years”, and would make “even the worst bankers look like absolute geniuses”.
These questionable quotes succeeded in doing two things. Firstly, it drummed up a whirlwind of PR attention at a time in which he is endeavouring to boost sales of his new book on Amazon – seemingly his primary objective. However, it also cast a spotlight on the peer-to-peer lending industry as a whole, and, in particular, put greater scrutiny on the safety measures platforms are providing in order to mitigate the risks to investors.
Although Turner’s comments are very much at odds with the sound, decade-long track record of P2P lending in the UK (and are rather ironic coming from a man who was at the helm of the FSA while the banks crashed around him during the recent recession), we welcome any scrutiny as we believe our levels of lender protection stand up to the test. We offer this protection in the form of the Lending Works Shield – a threefold model involving meticulous standards of credit underwriting, a unique insurance against borrower default, and a segregated Reserve Fund.
Our credit models and underwriting procedures are our first and perhaps most important line of defence against the potential for investor losses, while our unique insurance offers the third and final layer of protection by compensating lenders in relation to borrower defaults as a result of accident, loss of employment, illness and death, along with more sinister reasons such as fraud and cybercrime. Sandwiched between the two, though, is an important safety net which seeks to compensate lenders for any late and missed repayments – our Reserve Fund.
How does the Reserve Fund operate?
The Reserve Fund is an interest-bearing, segregated trust account with NatWest which was established prior to the launch of the business in January 2014. Funds are held exclusively in cash, and are topped up using a risk-weighted portion of the fees payable by each of our borrowers.
The sole and exclusive purpose of the Reserve Fund is to immediately compensate lenders for any missed or late payments (arrears) in order to ensure that they receive exactly what they’re expecting – when they expect it. Any use of the Reserve Fund is limited to those set out in the Lending Works Shield Trust Deed - Lending Works cannot access monies held within this account for any other reason, and this is kept entirely segregated from the day-to-day operational funds of the business.
Lending Works also has an agreement in place with an independent backup services provider, who would manage this account in the event of Lending Works ceasing trading, and use the funds therein to help ensure that lenders continue to receive capital and interest repayments due to them under their credit agreements.
Has the Reserve Fund been a success?
Fortunately at Lending Works, the Reserve Fund has always been more than sufficient to cover past arrears and defaults, without even considering the additional layer of insurance.
Our rates of default are well below projections, which is a testament to the standards and criteria of our credit underwriting model. Such minimal losses have to date been comfortably absorbed by the Reserve Fund.
In fact, the present balance of on-loan consumer lending capital (the Shield is not offered to institutional lenders) currently stands at around £15 million, while the Reserve Fund balance stands at £333,000. This equates to a bad debt coverage ratio of roughly 2.2%; clearly well above the levels of arrears and defaults above, and that’s without even factoring in the additional layer of protection: the insurance against borrower default.
Clarifying our approach to risk management
Incidentally, when taken to task on his comments by Christine Farnish, the chair of P2PFA, Lord Turner backtracked and apologised profusely. He claimed that what he had actually said was that only if UK platforms begin chasing after lower-quality borrowers, drop their standards of credit underwriting, and abandon the models for lender protection, would these “huge losses” ensue. He has even offered to speak at the next P2PFA event in order to ‘right any wrongs’ he has caused.
The important thing for our lenders to take note of is that it is very much in our interests as a platform to instil confidence and reassurance in the minds of our lenders, especially given that capital is at risk and not protected by the Financial Services Compensation Scheme. Which is exactly why we have gone the extra mile in terms of lender protection with our unique insurance, in addition to the significant buffer of our Reserve Fund when compared with actual and projected bad debts. After all, without our lenders – and, more specifically, lenders who believe and trust in the service we are offering – we wouldn’t be sustainable as a platform. That’s why we can say with the utmost sincerity that the customer really does come first, and you are in very capable hands with us as a result.