Investments with RateSetter are protected by the Provision Fund which provides a buffer against poorly performing loans. RateSetter aims to maintain the Provision Fund at a level intended to cover all expected future loan defaults. The Provision Fund has a 100% track record: to date, every investor has received the returns they expected. We are proud of this track record. However, this isn't a guarantee for the future and your capital and interest are at risk if the Provision Fund is depleted by increased borrower defaults, and investments are not covered by the Financial Services Compensation Scheme. Click here for more information about how we manage credit risk and what would happen if the Provision Fund were to become depleted.
The Provision Fund is made up of payments received from every borrower, based on RateSetter’s assessment of their creditworthiness when the loan is granted. Each investor is directly matched with one or more borrowers, but as the Provision Fund effectively spreads risk across the whole loan book, investors are exposed to the performance of the RateSetter loan book as a whole - not the performance of the specific loans they are matched to. Hence the performance of the RateSetter portfolio as a whole is important to each investor as the Provision Fund is designed to cover any non-performing loans across ALL types of lending.
In the past, RateSetter intervened with some of our borrowers in restructuring our wholesale lending. As a result, RateSetter now controls three businesses. In an exceptional case, one of these businesses went into financial difficulty and RateSetter has taken part of the loan to that business onto its own balance sheet. We did this because the loan was outside RateSetter’s credit policy and without the direct financial support of RateSetter this business would have defaulted on its loans and therefore have depleted the Provision Fund. We believe that it was appropriate, in this specific case, to stand in front of our investors. This is an exceptional case and it will not happen again.
Separately, RateSetter has acquired a stake in a fourth business. All four businesses have outstanding loans with our investors. New investments and any reinvestments may be matched with one or more of these loans. These loans are secured on the underlying loan portfolios of these businesses. Our acquisition of these businesses and stakes will not have a direct impact on the Provision Fund. The loans mentioned above are covered by the Provision Fund in the usual way, with the Expected Future Losses from the loans included in the Expected Future Losses figure published on our website. The only exception is the loan which RateSetter as a company is standing behind, so any losses on that loan will be covered by RateSetter itself rather than the Provision Fund.
How large is the Provision Fund buffer?
How is the Interest Coverage Ratio calculated?
|Provision Fund cash||£12,568,954|
|+ Expected Future Provision Fund Inflows||£8,442,321|
|Provision Fund Buffer||£21,089,777|
|÷ Expected Future Losses||£17,305,826|
|Interest Coverage Ratio||121%|
How is the Capital Coverage Ratio calculated?
|Provision Fund Buffer||£21,089,777|
|+ Expected Future Investor Interest||£31,179,949|
|÷ Expected Future Losses||£17,305,826|
Who do RateSetter investors lend to?
|Purpose||Car purchases, home improvement loans, debt consolidation and retail purchases||Loans to small and medium sized businesses to help them become more productive (e.g. Asset Purchase, Stock Purchase, R+D, Acquisition, Cash Flow, Expansion)||Secured property loans typically for property development (typically up to 65% Loan To Value)||Lending to individuals and businesses via third party specialist lenders (e.g. motor loans, guarantor loans)|
|Loan size||Typically £500 - £35,000 (in certain circumstances up to £100k)||£25,000 – £750k (with 3 existing loans > £750k)||Up to £7.5m||£2m up to £40m per lending business. They lend onwards to individuals (£1-10k) and businesses (£40-100K)|
|Interest rates||Typical borrower APR: 3.0% to 54.9%||Typical borrower APR: 5.0% to mid-teens||Typical borrower APR: 8.0% to 9.0%||Lending business borrows at: 7-10% Typical end-borrower APR: 40-60%|
|Sources of loans||Direct to RateSetter, price comparison website, other partnerships||Direct to RateSetter and Brokers||Direct to RateSetter and Brokers||Direct|
|Protection||Provision Fund provides “first-loss” buffer against credit losses. Loans are typically unsecured, except certain motor loans which are secured on the vehicle.||Provision Fund provides “first-loss” buffer against credit losses. Directors typically provide personal guarantees.||Provision Fund provides “first-loss” buffer against credit losses. RateSetter has security against all properties.||Third party lending business provides “first loss” buffer. Provision Fund only takes losses if the lending business defaults.|
|Expected Future Losses||Estimated based on quantitative analysis of actual loss data. Please see below for more information.||Estimated based on quantitative analysis of actual loss data.||Estimated based on the strength of the development and Loan to Value.||Estimated based on the probability of third party default and the costs of RateSetter taking over and running off the underlying loans.|
Table updated on 7 July 2017. Active loans figures correct as of 3 July 2017*We no longer write new loans to other lending businesses. Existing loans are running down as they repay over time in accordance with their existing loan schedule. However new lender money and reinvestments may be matched to existing loans.
^In the past, RateSetter intervened with some of our customers in restructuring our wholesale lending. As a result, RateSetter now controls three entities. Separately, RateSetter took a stake in a fourth business. All four entities have outstanding balances with our lenders. New investments and any reinvestments may be matched with one or more of these loans.
Any conflict of interest is mitigated by ensuring appropriate separation of the relevant operational teams from the companies in which RateSetter has a stake. Any credit and/or lending decisions made by RateSetter in connection with companies that are part of the RMM group are made independently from the management of RMM’s equity interests in those companies. In addition, RMM’s Compliance team carries out periodic reviews and reports the findings to the RMM Compliance Committee.
£698m Open loans on 3 July 2017
These charts are a snapshot, last updated on 3 July 2017
How are Expected Future losses calculations validated?
Expected future losses on active loans are recalculated by our risk assessment experts every three months.
Expected Loss Committee
Expected future losses figures are signed-off at RateSetter’s Expected Loss Committee, which comprises the CEO, CFO, Head of Consumer Credit Risk and Head of Commercial Credit Risk.
Board Risk Committee
The Board Risk Committee is responsible for signing off the expected future losses methodology and providing feedback on calculations.
In addition to contributing to the Provision Fund, we require some borrowers (such as property developers , small and medium sized business borrowers and other lending businesses) to provide security against their loan. This can include things like cars, residential properties, or financial assets. If one of these borrowers were to default, the Provision Fund would reimburse investors as usual, but it would also use the security to recover the outstanding debt. The latest estimated value of security held is:
This security is held against £118m of loans. These numbers are always updated on the first working day of each month, only include assets over which there is a fixed or floating charge, and do not include the value of any debentures taken over a business’s assets.
Find out more about the security held against loans
How does the Provision Fund work?
The good news is that it’s refreshingly simple:
1. All borrowers pay a risk-adjusted fee into the Provision Fund
2. Investors are reimbursed by the Provision Fund if a borrower misses a payment, providing there are sufficient funds available.
Money in the Provision Fund is held in a separate company called RateSetter Trustee Services Ltd. The company is obliged to reimburse investors when borrowers miss a payment providing there is sufficient money in the Provision Fund.
We have taken the prudent decision to spread almost half of borrower contributions to the Provision Fund over the lifetime of loans. Importantly, this provides a funding stream for the Provision Fund into the future, reducing pressure to write new loans simply to maintain the level of the Provision Fund. It is an added incentive for us to write loans that pay back in full, ensuring that we lend prudently, for the long term.
How RateSetter manages risk
The main risk to investors is that borrowers do not repay their loans. RateSetter seeks to mitigate this risk in a number of ways:
- Excellence in underwriting: robust credit and affordability checks on all borrowers.
- Portfolio management: Our loan book is diversified across many borrowers of different types and channels.
- The Provision Fund: if a borrower misses a payment, the Provision Fund reimburses investors; if the loan goes into default, the Provision Fund takes over the loan and repays outstanding capital to the investors.
This helps keep the Provision Fund coverage ratio at 121%, while our loan book grows and matures.
Active Default Management
For the small proportion of borrowers that miss payments, our specialist arrears management team has a 3-step plan designed to help get things back on track:
- Debt review and affordability analysis to assess borrower's unique situation
- Consolidation strategy offer to reduce debt repayments
- Repayment plan adjustments to increase likelihood of full repayment
You can see how the Provision Fund is held here.
Excellence in underwriting
We never forget that we're looking after your money. It's a responsibility that drives us to go beyond industry-standard processes and use a series of advanced systems and checks to ensure borrowers are creditworthy.
Not only do we use industry-standard credit checks from experts such as CallCredit and Equifax. We also use advanced credit checking software and external data feeds (such as telecoms industry anti-fraud tools) to give us a more holistic view of potential borrowers.
So as well as looking at credit history, we determine what they can currently afford, and more accurately forecast their future ability to repay a loan.
You can see our Principles of Lending by clicking here.
Highly skilled credit team
Processes and software are only as good as the people operating them.
That’s why we've invested heavily in skilled and experienced credit specialists. RateSetter is a member of Cifas, the UK’s fraud prevention service.
RateSetter Credit Committee
To ensure credit standards are constantly monitored and challenged, RateSetter’s Credit Committee continually reviews performance, with scrutiny by the heads of Credit, Compliance, the CFO and the CEO.
In addition to checking a borrower's credit rating, we carry out affordability checks. These ensure a borrower can continue to make repayments even if unforeseen expenses crop up. This is an approach we have followed from day one.
What happens if defaults increase?
As we lend to creditworthy borrowers, expected losses are low, but we're not complacent. We monitor the performance of loans closely and run regular scenario tests to model the impact of changes in default rates on the Provision Fund.
The following chart uses our published data to illustrate what the effect could be if losses increased. Of course, RateSetter actively manages Provision Fund contributions to reduce the potential impact on investors.
This chart includes contractual future income due to be paid into the Provision Fund, as well as interest due to investors, with an appropriate discount applied to both.
In short, if losses were to increase significantly, the following things would happen:
- The Provision Fund would reduce in value.
- It may take longer than expected to receive your money back and access to your funds may be restricted.
- The Provision Fund is large enough to cover expected losses 121 times over, but if it was depleted investors would earn less interest than they expected, but their capital would be unaffected.
- If losses rose further, investors would start to lose capital, which means that they would get back less money than they put in.
The Provision Fund is designed to absorb losses to protect investors. If losses increase, the Provision Fund reduces in size, because money is being taken out of it to protect investors.
If the Provision Fund runs out, further increases in losses would mean that investors begin to lose interest, although capital would be unaffected. In the chart above, investors' interest would reduce if losses increased to between 3.6% and 8.7%. However, investors would not lose capital: they would get back at least as much money as they put in.
Only when losses exceed 8.7% would investors lose any capital, and get less money back than they put in. If losses reached 14%, investors would be expected to lose 5.3% of capital (that is, they would get back just under 95p for every £1 they had invested).
For the sake of clarity, this chart makes two prudent assumptions, which mean that it underestimates the protection of the Provision Fund:
- RateSetter actively manages the Provision Fund, by determining how much borrowers pay into it. If the Provision Fund was falling significantly in value, it’s likely that RateSetter would increase contributions into the Provision Fund. This is not reflected in the chart.
- The chart assumes that any default is a total loss – but in reality, RateSetter makes substantial recoveries (which means that we are able to recover money owed to us even when it is defaulted), and these are repaid into the Provision Fund, increasing its size over time.
What happens if RateSetter ceases trading?
Thankfully, this is also very unlikely. But if the worst happened, we have a fully-funded run-off plan that would kick in, as required by regulation.
Contracts remain binding between investors and borrowers and loan repayments and the Provision Fund would continue to operate, even if RateSetter ceased trading.
During the winding up process any fees owed to RateSetter would be used to cover the costs of the run-off process to ensure that contracts with borrowers are fulfilled and investors are repaid in line with those contracts.
Investors’ money would always remain entirely separate to RateSetter’s money throughout the run-off process.
Security and recoveries
We have always reported on the size of the Provision Fund and will continue to do so. However, looking at the size of the Provision Fund alone does not provide the full picture of the protection provided. There are two other factors to consider: the security held on behalf of RateSetter investors and recoveries from defaulted loans.
In addition to the risk-adjusted contribution they make to the Provision Fund, we require that some borrowers provide security. The security is agreed on a case-by-case basis but can include things like cars, residential properties, or financial assets. If one of these borrowers were to default, the Provision Fund would reimburse investors in the usual way, but would also be able to use the security to recover the outstanding debt.
The current value of the secured loans and the estimated current value of the security is reported above. The value of the security is higher than the value of the loans because of the loan to value ratios that we factor into to our secured lending decisions.
The loan to values vary depending on the assets. In the case of money lent to other lending businesses where we take security over loans they write, the ratio is typically around 85%, while for loans to finance property development we aim for a ratio at or lower than 65%. Overall, we err on the side of caution when calculating the value of security held as we think it’s preferable to understate rather than overstate the position.
Other types of security
As it is not unusual for modern businesses to have few physical assets (for example, consider a web design company or a legal practice) but nevertheless be creditworthy, we may also take other forms of security such as debentures and personal guarantees.
In the event of a default, using the debenture or personal guarantee could include taking control of the business or putting it into administration. We deliberately take a narrow and prudent approach to reporting on the level of security held, so we do not include debentures and personal guarantees in that number.
The Provision Fund takes on non-performing loans and reimburses investors. However, even after a loan is transferred to the Provision Fund, we continue making efforts to recover the unpaid balance. This cash flow can be seen as an asset of the Fund, over and above the cash balances we show on the website.