Credit risk performance update - July 2020
Q2 2020 Performance Overview
Today we published our Q2 2020 performance update on our statistics page. This update comes as we continue to experience high economic uncertainty driven by the Covid-19 outbreak.
Since our last portfolio performance update, we have continued to focus on supporting loan customers who have seen their financial circumstances being impacted by the Covid-19 outbreak, which in turn protects the interests of our retail investors.
At the end of June 2020, approximately 6% of our loan book was on a payment deferral arrangement. We regularly benchmark our credit performance figures with all major UK lenders, and our payment deferral statistics are slightly better than the average across the industry, which gives us confidence that our portfolio will perform broadly in line with the wider market.
Since March 2020, we have also observed an increase in the percentage of loans which have one or more missed payments but are not on a payment deferral plan, compared to the beginning of 2020.
We have, therefore, increased capacity in our collections team to support loan customers who are facing financial difficulties, as we look to mitigate the Covid-19 related risks to our loan portfolio.
At the end of June 2020, we decided to extend the Normalisation Period for an additional 90 days, driven by the continued economic uncertainty.
Expected annual retail investor returns have decreased, compared to our Q1 2020 update. Average returns on past cohorts (2014-2019) have reduced from 4.9% to 4.6% p.a. for Growth investments and from 4.0% to 3.8% p.a. for Flexible. Average returns on the 2020 cohort have decreased from 4.8% to 4.2% p.a. for Growth and from 3.4% to 3.0% p.a. for Flexible.
We believe prudence is sensible during this unprecedented period, hence we expect to continue to divert all interest generated on the portfolio for loans associated with 2014-2019 cohorts to the Lending Works Shield for the foreseeable future, and in any case until the next performance update in October 2020.
Portfolio performance has continued to deteriorate in line with macroeconomic conditions
Our credit risk team maintains a comprehensive set of reporting and MI to closely monitor portfolio performance and to ensure our lifetime losses model reflects the most recent portfolio performance.
We ensure that our credit risk models are adequate and perform effectively through robust model governance, within which monitoring of model performance is completed every quarter. Our lifetime losses model is approved by Lending Works' Credit Risk Committee, while expected losses, returns and Lending Works Shield statistics presented on the website are approved every quarter by the Board of Lending Works Trustee Limited.
We have today updated our performance statistics which can be summarised as follows:
• Expected annual returns have reduced, driven by the diversion of all interest payments on the portfolio to the Lending Works Shield for 2014-2019 cohorts for the foreseeable future, combined with higher expected annual loss rates following our latest model monitoring process
• Expected annual loss rates have increased since our Q1 2020 update, mainly driven by the most recent performance of the portfolio and the current macroeconomic conditions
Expected annual losses have been updated to reflect the most recent portfolio performance, but we have not stressed the entire active portfolio in our calculations as the impact of Covid-19 on the economy and UK consumers are still uncertain.
Overall expected annual losses on the active portfolio increased from 3.5% in Q1 2020 to 3.8% in our Q2 2020 update and we anticipate a further increase in loss rates in the short-medium term future as the full impact of Covid-19 is realised during the second half of 2020.
We acknowledged that we see an economic disruption which will result in higher credit risk losses than in recent years. However, the full impact of Covid-19 on our portfolio is still unknown as loan customers are using payment deferrals to manage their financial circumstances, therefore it will not be until later in 2020 that we will have a more complete view of the quantum of the impact. We plan that our Q3 2020 portfolio performance update, which will be published in October 2020, will account for the full potential impacts from the Covid-19 outbreak in our active portfolio.
The impact of Covid-19 on portfolio performance
The Covid-19 outbreak is an unprecedented event, and in Q2 2020 we continued to observe high economic uncertainty. The responses of the Government and the FCA have also further developed since our last update, which means that forecasting the full impact Covid-19 will have on the Lending Works portfolio is still difficult.
On 1 July 2020, the Financial Conduct Authority (FCA) mandated that lenders should continue to provide payment deferrals to customers until 31 October 2020. We fully aligned our payment deferrals policy to the latest FCA guidance. Therefore, it will not be until Q4 2020 that we will have a full view of loan customers' ability to resume their loan repayments. Therefore, there is significantly more uncertainty in our analysis and forecasts than there usually would be.
To date, approximately 1,500 payment deferrals have been provided to our loan customers, and at the end of June 2020 approximately 1,000 were still active, which accounts for approximately 6% of our loan book.
We regularly benchmark our credit performance figures with all major UK lenders, and ours are slightly better than the average across the industry, which gives us confidence that our portfolio will perform broadly in line with the market.
We observed that loan customers who have requested a payment deferral are mainly characterised by one or more of the following:
• Loan customers within the less creditworthy segments
• Loan customers who have reduced monthly disposable income
• Loan customers who work within sectors which have been more severely impacted by the Covid-19 outbreak such as construction and property, hospitality, retail, transport and logistics
We also saw a decrease in the number of loan customers requesting payment deferrals each day, which reduced from approximately 17 to approximately 5 per day in June 2020, compared to previous months.
We expect that the majority of our loan customers will resume their monthly repayments at the end of the payment deferral period. Unfortunately, though, some will not, therefore it is not possible to accurately forecast the full impact Covid-19 will have on our portfolio using historical forbearance trends because of the unique nature of the current economic environment.
We will continue to monitor portfolio performance with a focus on both customers who are or have been on a payment deferral as well as customers who entered collections during this period. Our collections and recoveries capabilities have been strengthened to help ensure that we have minimised the effect of Covid-19 on investor returns.
Finally, as per our April 2020 performance update, we paused new lending at the end of March 2020. When it is appropriate to resume new lending we will do so with tightened creditworthiness and affordability criteria, and we will also ensure that the contributions from new loans into the Lending Works Shield are appropriate for the current economic environment.
The Lending Works Shield
The changes we made in late 2019 have resulted in a more resilient Lending Works Shield and while we could not have anticipated that there would be a worldwide pandemic, we continue to believe that the ability to use variable interest rates to account for variations in the performance of the portfolio performance protects investors and their returns over the lifetime of their investments.
Since the beginning of the Covid-19 outbreak, we have observed two key trends: firstly, loan customers who have seen their income affected by the Covid-19 outbreak and have been granted a payment deferral; secondly, loan customers who have entered in arrears in recent months but no payment deferral or forbearance treatment has been requested. This has resulted in an increase in the percentage of loans which have one or more missed payments, compared to the beginning of 2020.
The Shield future income, which is required to cover expected losses, increased to £8.0m, compared to £7.2m in Q1 2020. It reflects the most recent performance of the portfolio, primarily driven by 2017-2019 cohorts, and the macroeconomic conditions.
The Shield cash balance decreased from £0.92m in Q1 2020 to £0.52m in Q2 2020 mainly driven by two factors:
• Firstly, no further upfront fees as new lending was paused from March 2020
• Secondly, Shield utilisation has been high for 2014-2019 cohorts as we observed an increased volume of loans entering collections driven by Covid-19
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 retail investors holding 2020 loans, and the utilisation of the Shield for 2020 loans has been comparatively low.
We expected to continue to divert all 2014-2019 cohorts' interest payments to the Lending Works Shield for the foreseeable future. However, portfolio performance will continue to be closely monitored, and the Lender Rate Adjustment mechanism will be used to ensure expected losses are adequately covered by the Lending Works Shield at each given point.
Our retail investor and loan customer profile
The overall profile of our retail investors and loan customers 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.
Our next statistics page update will be in October 2020, and it will continue to be focused on the impact Covid-19 is having on Lending Works' portfolio performance.