One tricky issue that I face is when a company borrows large sums of money from multiple platforms before repaying his earlier loans. An SME that originally appears to have fairly low risk with moderate debt level can suddenly become a risky borrower that keeps borrowing loans with shorter duration and higher interest rates. Investors usually do not see the full picture of the SME’s debt situation until it is too late. And they are also helpless because there are no covenants on the p2p loan to prevent over-borrowing. I think p2p borrowers need to demonstrate good faith by stating clearly how much debt they really need over the next 12-24 months. And the p2p loans should include terms that prevent excessive borrowing.
Example 1: Ticketing Agent (VL)
In Jan this year, I participated in a $200k, 12-mth loan to a Ticketing Agent. This company has a DP2 rating, which implies a very low default probability (0.1%-0.2%). Debt was moderately high (leverage ratio slightly over 100%), but the company’s revenue is relatively stable and should be able to service its debt (pre-tax interest coverage = 25x). After the loan is disbursed, I discovered that the company is borrowing on multiple platforms. Some of the newer loans had high interest rates and very shorter duration. When I dug deeper, what I’ve found is not pretty. See below.
|Date||Loan Amount||Loan Duration||Eff Interest Rate (Annualized)|
|Oct 2015||$300k||12 month||24%|
|Dec 2015||$100k||1 month||72% (6% per month)|
|Dec 2015||$240k||1 month||60% (5% per month)|
|Jan 2016 (my loan)||$200k||12 months||23%|
|Jan 2016||$110k||2 month||60% (5% per mth)|
|Feb 2016||$100k||1 month||60% (5% per mth)|
|Mar 2016||$150k||3 month||60% (5% per mth)|
By now, it is obvious that the risk to this borrower is quite high. The DP2 rating (which is based on 2014’s financial statement) is definitely out of date. The company must be desperate, otherwise it would not have borrowed increasingly large amounts at such exorbitant interest rates. So far, this borrower has not defaulted, but if I had known the full picture, I would definitely not have lend to this borrower.
This is not the only case of SME borrowing from multiple platforms. I know of easily more than 10 such companies: Rupini, S Travel, Rex, TLC, Vertical Line, Proway, Olive Green, Advanced Wall, PWGS, Btech, FTMS, etc. To be fair, some of the debt levels are still quite decent despite borrowing from different platforms.
Why companies borrowing from multiple platforms is problematic for investors
- The borrower’s credit rating, which is based on past financial statements, becomes useless when the loan amount increases quickly.
- Investors do not see the full picture of the borrower’s (current and future) debt which can quickly turn excessive.
- Because some platforms do not disclose the identity of the borrowers, investors may accidentally lend to the same borrower across different platform, resulting in concentration risk
What if the borrower has legitimate reasons to borrow from multiple platforms?
To fair, borrowers have the right to seek loans from multiple platforms. Some borrowers also demonstrate good faith. One example is a Plastic Injection Company [PW] that requires loans to be disbursed on a sequential manner – as new orders come in. It borrows from the different platforms (MS, FS and CM) and discloses details in transparent manner. When I lend to PW, I know that the company will seek an additional loan, probably from another platform, at a later date. Unfortunately, “good” lenders such as PW are rare. More often than not, I’m caught by surprise when an SME that I’ve previously lent to, is borrowing again on a different platform.
Can investors leave it to p2p platforms to handle this risk?
My observation is that platforms prefer to lend a fresh loan only after the borrower repays the earlier loan. This is a cautious approach. Unfortunately, the same borrower can approach multiple platforms to borrow. What makes this even more challenging is that there are always new platforms coming up. And the platforms may not check with each other (they are competitors). One good example is FundHere extending a loan to an educational provider that I previously lent to on MoolahSense. Although it is not a case of overborrowing, the problem is that FundedHere is a platform only for accredited investors, hence information of the loan will not be known to the unaccredited investors. This situation came to light only because an investor posted it on Forum@Let’s Crowd Smarter.
What solutions are there to protect investors?
The best solution is for borrowers to disclose their current level of debt and any potential borrowing for the next 12-24 months. Investors will have an idea of how the debt level will look like in the near term and decide or not to lend. Secondly, debt covenants such as interest coverage and debt ratios should be imposed to prevent over-borrowing. Finally, a “free look” period of 1-2 days before loan disbursement should be given to allow investors to opt out in case the investor has already lent to the same borrower on another platform.
Of course, this is all so easy for me (as an investor) to suggest. For platforms looking to implement this, there may be operational issues that I may not foresee. And changes will take time.
An interim measure
One interim measure that I can do is to use Forum@Let’s Crowd Smarter (see here) to list down the borrowers that I know of having multiple loans on different platforms. Other p2p investors can also pool together their collective knowledge. With this, p2p investors can check if any borrowers have any record of excessively borrowing.