Interview with Michael Hoare, Chief Credit Officer
Michael Hoare oversees RateSetter’s credit function. We talked to Michael about how RateSetter manages lending risk and the Provision Fund.
What does a Chief Credit Officer do?
My role is to manage lending risk with the objective of ensuring that risks are identified, understood and priced into RateSetter’s loan underwriting. This covers the whole underwriting process from setting lending criteria and credit policy to analysing portfolio performance, as well as anti-fraud measures. As you would expect, managing credit risk well is a key priority for any respectable finance business – only by getting this right can we effectively balance risk with generating healthy returns for investors.
What did you do before joining RateSetter?
I was Chief Credit Risk Officer at PayPal UK where I oversaw underwriting, customer management and collections strategies for unsecured consumer and small business lending. Prior to that I was Credit Risk Management Director at credit card service company Capital One.
How does RateSetter estimate the risk of loan applications?
Our approach is similar to that of banks, which probably isn’t surprising given we approve similar quality borrowers. For personal loan applications, we take numerous data sources into account (including data directly from applicants and also from credit bureaux such as Experian, Equifax and TransUnion) in order to decide if the applicant can afford the loan and how likely they are to repay the loan. This data is processed quickly and automatically for each application, meaning that we can usually provide an applicant with a decision within 60 seconds for smaller loans. Some applications need some further consideration or additional information and are passed on to our experienced team of loan underwriters for a decision.
For asset-backed loans such as property development loans, the decision is more manual based on analysis and assessments by our team of experienced specialist underwriters. They look carefully at the development proposals, the expertise and experience of the property developer and the value of the property to reach a decision. When we approve property development loans, we take a conservative approach to the loan to value ratio.
Loans to motor dealers are handled in a similar way. We look at the financial state of the business, the reason for seeking a loan and the quality of the security being provided before making a decision on the application.
Every loan we approve has an interest rate which is integrally linked to our assessment of the borrower’s creditworthiness. The Risk team is instrumental in deciding how much contribution to the Provision Fund that should be made by the borrower. This in turn affects the interest rate they are charged.
How creditworthy are RateSetter borrowers?
People that come to RateSetter for a loan tend to be those that shop around for the best deal, for example via a price comparison website. This means that they are good quality borrowers who could expect to get approved by their bank but want to look for a competitive price.
RateSetter was one of the first finance businesses in the UK to publish a summary of our lending policy, which can be found here.
What is the Provision Fund’s Interest Coverage Ratio and how is it calculated?
The Interest Coverage Ratio measures the Provision Fund’s ability to cover expected future losses across the whole active loan portfolio. We calculate the Interest Coverage Ratio by adding up the money currently in the in the Provision Fund, plus the expected future inflows, and dividing by the expected outflows – in other words the amount we expect it will need to pay over the lifetime of all the active loans in the RateSetter portfolio.
Provision Fund Inflows. Every borrower pays into the Provision Fund in two ways: via an upfront cash payment when the loan is taken out, and via regular payments over the lifetime of the loan contract. Spreading payments over the lifetime of the loan is positive as it provides a contractual income stream into the future, reducing pressure to write more loans simply to keep adding upfront payments into the Provision Fund. We know that some loans will pay back early while others may not pay back in full, so we apply a discount or reduction to our forecast of future Provision Fund inflows.
Expected Future Outflows. Every quarter, we analyse the most recent data for each type of lending and re-examine our performance forecasts and expected Provision Fund outflows based on this data. Our performance forecasts for each year of lending can be found on the statistics page. More information about how we calculate expected Provision Fund outflows for consumer loans is provided in a separate blog here.
We aim to ensure that the Coverage Ratio is as objective and accurate as possible. Therefore, every quarter we review the RateSetter loan portfolio and a range of data including:
- Our latest detailed analysis on how loans are performing and how we can expect them to perform in future.
- Changes to the mix of loan types in the portfolio and our analysis of what this means for current and future performance.
- Refinements in our loan decisioning, underwriting and approvals processes.
- Trends and updates in collections and recoveries.
We use this analysis to update the figures that underpin the Coverage Ratio as notify investors each quarter when this is complete.
How do you make sure the Coverage Ratio is as accurate as possible?
There are three important components to the Interest Coverage Ratio:
- Cash from upfront payments when loans are written
- Expected Future Inflows from payments over the lifetime of loan contracts
- Expected Future Outflows
Cash in the Provision Fund is independently audited on an annual basis as part of RateSetter’s financial audit.
Expected Future Inflows and Expected Future Outflows are projections of future performance - RateSetter now has almost 10 years of data and this enhances our ability to make accurate inflow and outflow forecasts.
Our projections are based on modelling methodologies and are prepared by our Risk Analytics team who report into me, and I am in turn accountable to the Executive Credit Committee and our independent Board Risk Committee. We are also looking at whether our projections can be externally analysed in future.
What tools does RateSetter use to respond to changes in size of the Provision Fund and the level of the Coverage Ratio?
The Coverage Ratios provide the latest snapshot of the buffer that protects RateSetter investors’ interest and capital. They are a snapshot because they assume that RateSetter does not introduce additional measures to manage credit risk.
Unlike other investments which can rise and fall quickly and unpredictably (such as equities), the performance of loans takes several months and years to play out. Actions we can take include:
- Changing the mix of loan types in the portfolio as new loans are written.
- Refining loan decisioning, underwriting and approval processes.
- More collections and recoveries.
- Using risk-based pricing to add more funds to the Provision Fund.