Sponsored post: not all loans are created equal – comparing P2P lending

British Pearl explains how it has launched a P2P loan model that better enables investors to manage risk.

The old model of borrowing and lending has changed.

Technology now enables many individuals to come together and lend small amounts that are pooled together to make up a loan.

Today the terms ‘P2P’ and crowd investing cover many different models and investors need to understand the specific risks they are being exposed to.

We have been in an environment of generally rising asset prices across the risk spectrum.

This economic backdrop can build up the level of risk being taken by investors as they may fail to differentiate between the various assets that are provided by borrowers as collateral to support the lending they have done.

What happens if a borrower defaults?

The key risk metric to understand when investing in these or any loan product is whether you are able to recover your loan principal should a borrower default.

During times of economic and asset growth, default levels remain suppressed and it is only when asset price growth begins to flatten out, or even fall, that the products containing the higher levels of real risk are exposed.

Default levels rise and ultimate recovery rates fall, meaning the higher returns that are initially promised can very quickly turn into capital losses.

Fundamental to understanding and quantifying these risks, is working out (i) the relationship between the customer as a lender and, on the other side of the transaction, the borrower, and (ii) the nature of the borrowing party; is it a special purpose vehicle (SPV), an individual or something else? .

Most P2P mortgage/loan companies act as an intermediary between lenders and borrowers, meaning the loan repayment is subject to the performance of a third party.

As a result, investors can be exposed to the full credit/counterparty risk of a borrower who is independent of the platform provider.

How British Pearl works

British Pearl is different because we are not a P2P intermediary.

The borrower is an SPV that holds the properties that British Pearl manages as an FCA regulated alternative investment fund manager.

We source, secure and manage the property on behalf of our investors.

The lender is only exposed to the credit/counterparty risk of that SPV, which is managed by British Pearl, a company operated by property and investment professionals with a successful track record.

There is no third party such as a property developer on the receiving side of the loan and lenders hold a first charge over the property.

British Pearl has a direct relationship with all lenders and, as a result, is highly incentivised to ensure all investments follow a strict due diligence process that clearly details all risks and the full financial projection over the investment term.

Boosting your seniority

One of the key differentiators with regards to risk is the ‘seniority’ of the loan.

So if there is a default by the borrower, where do you as a lender rank in terms of priority for having your capital repaid.

The most secure is a first charge on the underlying security.

This is where a bank mortgage on a residential home would normally be ranked and means that you are first in line to be paid out by the SPV.

It is also where British Pearl investors are ranked.

A second charge means that the security level you hold is considerably weaker.

A second charge loan will only become eligible to receive payments once any first charge loan has been repaid in full.

The second key differentiator with regards to risk is the ‘loan to value’, or LTV, of the loan.

This measures how large the loan is in relation to the value of the underlying asset that forms the security for the loan.

A higher ratio means that the loan is riskier and a lower number is safer because there is more of a buffer should the value of the asset fall An LTV of 70% means that the underlying asset (in our case property) would need to fall in value by 30% to put the loan principal at risk, i.e. if the asset was sold, the entirety of the loan would not be repaid from the proceeds of sale.

All British Pearl loans are currently offered with a range of LTVs from 50 to 70%.

How to evaluate

The key questions to ask yourself when comparing different investment models that are put under the P2P umbrella are:

1. What is the probability of the borrower defaulting?
2. If the borrower defaults, how safe is my loan principal?
   1. Is the borrower incentivised to default under any circumstances such as falling asset values or a tough market backdrop?
   2. How much of the capital will remain after a default?
   3. Can I recover capital from another source such as (i) selling some security that the borrower placed as collateral or (ii) through a reserve fund offered by the investment platform?
   4. Will the approach to recover some or all of my capital take time and money through a prolonged legal process?

Understanding these risks is crucial for all investors and should be a core element of the due diligence when choosing platforms and investments.

This is a paid promotion by British Pearl and does not necessarily reflect the views of loveMONEY.