Credit risk performance update - April 2020
Ines Maia joined Lending Works as Head of Risk in February 2019. Ines has more than 10 years of experience in risk management, credit risk decisioning and analytics. Prior to Lending Works, Ines was responsible for credit risk management for Personal Loans at a UK high street bank, where she was a member of the credit committee and risk committee, and she started her career in financial services consulting at Deloitte.
As Head of Risk, Ines is responsible for the development and implementation of Lending Works' risk management approach. Ines also leads a team of credit risk analysts and data scientists who use advanced data science, such as machine learning, to create powerful credit models which drive our lending decisions.
Today we published our Q1 2020 performance update on our statistics page. This update comes as we all experience unprecedented disruption and uncertainty driven by the Covid-19 outbreak.
The full impacts of Covid-19 on the economy and credit markets are still relatively unknown. It is therefore also complicated to predict the effect it will have on our loan portfolio at this stage. However, we are continually monitoring portfolio performance, and we are taking all the measures we feel are appropriate to support our loan customers while also protecting the interests of our investors.
Expected annual investor returns have slightly decreased, compared to our Q4 2019 update. Average retail investor returns on past cohorts (2014-2019) have reduced from 5.2% to 4.9% p.a. for Growth investments and from 4.2% to 4.0% p.a. for Flexible. Average retail investor returns on the 2020 cohort have decreased from a target rate of 5.4% to 4.8% p.a. for Growth and from a target rate of 4.0% to 3.4% p.a. for Flexible.
We believe prudence is sensible during this unprecedented period. That said, if the measures we have taken are overly prudent, the Lender Rate Adjustment mechanism will be used to increase expected annual returns received by investors over the lifetime of the loans in their portfolio.
It is essential to highlight that the loan performance data and, therefore, statistical analysis that is available to us at this moment in time does not give us the full picture of the Covid-19 crisis. So far, the only significant variance in our data is an increase in borrowers utilising payment deferrals, and it won't be until July 2020 that we will have a first view of those borrowers' ability to resume their loan repayments. Therefore, there is significantly more uncertainty in our analysis and forecasts than there usually would be.
Portfolio performance has deteriorated in line with macroeconomic conditions
Each quarter we update our performance statistics after running a range of credit risk and investor statistical models. The output from that exercise at the end of Q1 2020 is as follows:
• Expected annual returns have reduced, driven by diverting all interest repayments to the Lending Works Shield for all active cohorts during Q2 2020 combined with higher expected annual loss rates in the portfolio.
• Expected annual loss rates have increased since Q4 2019 update mainly driven by the most recent performance of the portfolio and macroeconomic conditions.
Expected annual losses have been updated to reflect the most recent portfolio performance, macroeconomic conditions and the credit risk of new loans funded in 2020.
We will continue to closely monitor Lending Works' risk exposure and overall portfolio performance. In H2 2019, we tightened our credit risk strategies to reduce exposure to both high-risk and concentration segments. In Q1 2020, we further enhanced the controls we have in place during these unprecedented times.
Furthermore, at the end of March 2020, we decided to pause new lending due to the current unprecedented environment. As a responsible lender, we need to ensure we can accurately assess each borrower's affordability which is currently extremely difficult due to the wide-ranging impacts the Covid-19 outbreak has had on household income for the majority of the UK population.
We will continue to monitor our key indicators closely, and we are confident we have the controls in place to steadily resume new lending when it is an appropriate time to do so. We have data and systems in place that allow us to react quickly and make changes to our lending criteria rapidly when required.
Overall expected annual losses on the active portfolio have increased from 3.2% in Q4 2019 to 3.5% in our Q1 2020 update and we expect that the Covid-19 outbreak could lead to a further increase in loss rates in the short-medium term future.
The Lending Works Shield
In late 2019, we announced changes to the way the Lending Works Shield operates which mean that interest rates paid to investors are now variable, if required, to account for variations in the performance of the portfolio.
Given the current Covid-19 uncertainty, it is very difficult for us to assess the impact this crisis will have on Lending Works borrowers' ability to repay their loans over the coming months. Therefore, on 6 April, we started to divert all interest payments to the Lending Works Shield for all active cohorts. This is planned to be a temporary measure which coincides with the 90-day Normalisation Period also announced on 6 April.
The Shield future income, which is required to cover expected losses, has increased since the last update and sits at £7.2m (£5.4m in Q4 2019) which reflects both the most recent performance of the portfolio, primarily driven by 2018-2019 cohorts, and wider macroeconomic conditions.
The Shield cash balance has increased to £0.92m in Q1 2020, mainly driven by two factors:
• Firstly, in March 2020 we completed a sale of a batch of defaulted loans which added £0.39m to the Lending Works Shield.
• Secondly, £0.49m is associated with the 2020 cohort, which is still at an early stage of its maturity; hence Shield utilisation remains low. The way that the Lending Works Shield now operates means that there is no contagion risk between cohorts, i.e. the contingency fund cash balance associated to 2020 loans will only be used to make repayments to relevant investors with 2020 loans.
The effects of Covid-19 in the broader economy and credit markets are still unknown. Therefore, it is very difficult to accurately predict how our portfolio will be affected at this stage. As well as Lending Works' internal data, there is limited public data available about the effects of Covid-19 on credit performance. For example, the recent Q1-20 Bank Of England Credit Conditions Survey reports on the period between January and March 2020, hence not covering the period when the full effects started to be felt in the UK, i.e. from April 2020 onwards.
As a result, we have taken the temporary prudent measure to divert all interest repayments to the Lending Works Shield. However, if this measure is proven to be overly prudent, we will increase the expected annual returns received by investors over the lifetime of the loans in their portfolio once more is known about the impact of Covid-19 in our portfolio.
Our Stress Testing Framework, which is based on UK publicly available information, defines the peak point in the economic cycle in the UK, with the long-run average representing the Through The Cycle (TTC) point. It suggests that if the recession and economic impact are approximately as bad as 2009, then capital losses would be limited.
Our investors and loans profile
The overall profile of our investors and loans has remained stable, compared to the last update, and we do not anticipate any significant changes to the profile of customers in the near future.
You can find out more about our typical customers on our statistics page.
In March 2020, we completed a sale of a batch of defaulted loans which resulted in £0.39m being added into the Lending Works Shield. This equates to the total proceeds from the debt sale.
The way the Lending Works Shield works is simple - if a scheduled loan repayment is missed, or a loan defaults, the Shield will step in to make the repayment to the relevant investors instead. Any money subsequently recovered from the borrower goes back into the Shield contingency fund.
However, inevitably, sometimes we exhaust our recoveries strategies via either our in-house team or our debt collection partners, and we are unable to increase recoveries on defaulted loans any further. Therefore, the best outcome is often to work with an FCA-regulated debt purchasing company to purchase those defaulted loans.
We aim to complete debt sales fairly regularly in the future, for example at least annually, which will allow us to boost the contingency fund cash balance regularly.
Supporting borrowers impacted by Covid-19
At Lending Works, we started to provide payment deferrals to borrowers affected by the Covid-19 outbreak in mid-March 2020 and ahead of the FCA guidance on unsecured personal loans. Supporting our customers is at the centre of everything we do, hence offering additional support and flexibility to our loan customers during this challenging time was a key focus for us.
Since 9 April, we have fully aligned our payment deferrals policy to the FCA guidance. All customers whose income has been affected by the Covid-19 outbreak are eligible for a 3-month break from making their loan repayments with no impact on their credit file.
We know that this is a difficult time for our loan customers and as at the end of March 2020 approximately 140 payment deferrals were given to customers, which accounts for c.1% of our active loan book. Since the FCA announced their measures on 9 April, the number of customers that applied for payment deferrals increased and, up until 24 April, we have now processed c.600 payment deferrals, which equates to c.3% of the active loan book.
In our Q2 2020 update, which will be published in July 2020, we will have a full view of the total payment deferrals granted as a result of Covid-19 as well as an early indication of the potential impact this is likely to have on the portfolio performance. At the end of the payment deferral period, some borrowers may still be facing financial difficulties and will, therefore, be unable to resume making their loan repayments, which could lead to an increase in forbearance cases.
Finally, it is important to note that we have paused new retail investor funded lending and strengthened our collections and recoveries capabilities to help ensure that we have minimised the effect of Covid-19 on the investment accounts of retail investors.
Our next statistics page update will be in July 2020, and it will be focused on Q2 2020 performance and an early view of the Covid-19 outbreak impact on Lending Works' portfolio performance.