An investor recently asked me about the things I look out for when I choose my p2p loans. I’m no expert, but I have previously worked as a credit officer in a bank. Hence, I do have some basic credit analysis skills. Below are some of the things I focus on. Also, there is a recent post on MoolahSense’s forum on the same topic that contains plenty of useful tips too!
Business and Industry
I like industries that are stable and non-cyclical, such as education, transport and healthcare. These industries should be less affected even if Singapore or the world enters into a recession. For cyclical industries such as construction and oil & gas, I tend to be more cautious and prefer companies that have some niche.
I prefer loans that are for expansion within the borrower’s area of expertise. If a reasonably-run restaurant is seeking funds to open a second outlet, I’ll probably lend. But if it is doing something different like organizing a mass run, then the execution risks are much higher. If a borrower states the loan purpose as “working capital” without further elaboration, I will not lend. There is a defaulted case where the borrower states the loan purpose as to purchase more supplies in order to earn a higher margin. Yes, you get a discount for bulk purchase. But it is a speculative activity; if you can’t sell the supplies to someone else, you will be stuck.
I always try to understand how the borrower intends to repay. Sometimes this information is not provided and will require some further analysis. If the loan is for a new outlet, then the repayment usually comes from the existing business because the new outlet will take time to be cash-flow generative. I will then look at its previous year’s net or operating profit line to see if the company can produce enough earnings to repay and service the loan.
Profit margin – In general, the higher the better. Some industries (e.g. retail or trading) have very low margins. In these cases, I will also look at the turnover and the net profit figure.
Interest Coverage Ratio – A high figure (e.g. 10x) is good. This means that the company can service its interest repayment as long as the business stays the same. For cyclical industries or businesses that are project-based (i.e. contractors), then this figure is less useful.
Receivable days – Receivable days give an estimation on how many days the borrower’s customers take to pay them for their service. Anything above 90 days is risky to me and I will check to ensure that the revenue and cash collection are very secure (e.g. long-term contract and not open to disputes).
Current/quick ratios – I don’t find this useful because most p2p borrowers have ratios below 1. Think about it – if borrowers have ample liquidity to cover for a year’s of short-term liabilities, they wouldn’t be seeking p2p loans in the first place.
Growth ratios / ROE / ROA – I don’t find these useful. I’m a lender and not an shareholder. I don’t want exciting growth stocks. I want boring but steady companies that will repay me my money rain or shine!
Have I missed out on anything? What other things do you look at? I’ve love to hear your comments.