Security held

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:

£146 million

This security is held against £122m of loans. These numbers are updated 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.

While transitioning these fees from being purely upfront (i.e. payable at the point a loan is taken out) to being spread over the loan’s term initially has a temporary effect on the flow of funding, this will balance out over time. Importantly, it 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.

To show faith in the quality of our underwriting, RateSetter has put our own money into the Provision Fund. For example, when RateSetter launched in 2010 we kick-started the Provision Fund with a loan of £150,000, and in 2015 we increased our commitment by making an additional loan. Putting our own money is another way we align our interests with our investors in terms of ensuring good credit performance.



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 128%, 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:

  1. Debt review and affordability analysis to assess borrower's unique situation
  2. Consolidation strategy offer to reduce debt repayments
  3. Repayment plan adjustments to increase likelihood of full repayment

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.


Affordability

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.


Independent review

Despite having total confidence in our processes and the decisions we make based on 5 years of data and over 8.4 million historic personal records, we still feel it's vital to get external validation.

That's why in 2014 we asked leading credit reference agency Equifax to carry out an independent review of our systems and processes. They said:

“RateSetter has a comprehensive and well-documented underwriting process.”
Equifax
“It is evident that the quality of RateSetter is very much in line with a benchmark group of similar super-prime unsecured loan providers”
Equifax

Portfolio management

By investing with RateSetter, you’ll be lending to a diverse range of individuals and businesses (including companies, partnerships, sole traders, property developers and other lending businesses).



What happens if defaults increase?

The level of defaults can change over time, and we monitor the performance of loans closely.

The following chart uses our published data to illustrate what the effect for investors could be if loan default rates were to increase. Of course, RateSetter actively manages Provision Fund contributions to reduce the potential impact.



*An estimate of how RateSetter’s consumer loans would fare in 2009’s credit conditions based on Equifax data

This chart shows what would happen to investments on the RateSetter platform at various default rates.

In short, if defaults were to increase significantly, the following things would happen:

  1. Firstly, the Provision Fund reduces in value.
  2. It may take longer than expected to receive your money back and access to your funds will be restricted.
  3. The Provision Fund is large enough to cover expected defaults 128 times over, but if it fell to zero then firstly, the amount of interest earned would decrease: the money that investors put in (capital) would be unaffected but they would earn less interest than they expected.
  4. If defaults rise further, investors would start to lose capital, which means that they would get back less money than they put in.

In detail

The Provision Fund is designed to absorb defaults, so investors are protected from losses as long as the Provision Fund has money in it. If defaults increase, the Provision Fund reduces in size, because money is being taken out of it to repay investors.

If the Provision Fund runs out, a Resolution Event would be declared (see next section), and further defaults would mean that investors begin to lose interest – that is, the full amount of capital that they put in would be unaffected, but they would receive less interest. In the chart above, investors' interest would reduce if defaults passed 3.8% until defaults reached 11.5%. However, they would not lose capital: they would get back at least as much as they put in.

Only when the default rate exceeds 11.5% would investors lose any capital, and get less money back than they put in. If default rates reached 14%, investors would be expected to lose 2.5% of capital (that is, they would get back just over 97p for every £1 they had invested).

For the sake of clarity, this chart makes three 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.
  • Borrowers pay into the Provision Fund regularly, over the lifetime of the loans. This ongoing contribution into the Provision Fund 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 the Provision Fund becomes depleted?

The good news is that this is highly unlikely - the Provision Fund has grown significantly in size over time and currently stands at £16,812,729 and we actively manage contributions to ensure that it is well funded.

In the event of the Provision Fund becoming depleted, RateSetter would declare a ‘Resolution Event’. This would mean that all outstanding loan contracts would be automatically assigned to the Provision Fund, and all loan repayments would be collected by the Provision Fund on behalf of investors.

Repayments would then be shared out (pro rata) to investors to ensure diversification of default risk. There would be a material delay in repayments being made.

The Resolution Event would work to give all investors a reimbursement of, for example, £0.95 on every £1.00 invested.


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.

Security

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.

Recoveries

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.

How the Coverage Ratio is calculated

This figure shows the percentage of bad debts we predict the Provision Fund would be able to cover. It is calculated by taking the size of the Provision Fund, adding Contractual Future Income and dividing by the expected level of future losses from active loans.

The Coverage Ratio is a real time measure of the Provision Fund’s ability to cover expected bad debts. It is calculated by dividing the size of the Provision Fund by the expected level of future losses from active loans.


Expected loss

The expected loss for every active loan is calculated by giving the loan a likelihood of default and then taking into account the fact that we do often recover money after a default occurs. We then aggregate the figures to give a total expected loss figure.

The likelihood of default is anchored in the huge amount of information we receive from credit reference agencies on personal loan performance and is then updated based on our own empirical information as the loans mature (note that the likelihood of default decreases as the loans are repaid).

Objectivity and accuracy

We aim to ensure that the Provision Fund Coverage Ratio is as accurate and as objective a measure of the strength of the Provision Fund as possible.

We keep the Coverage Ratio methodology under review as the amount and maturity of our RateSetter-specific data increases and we communicate updates in our blog. This, along with the wider range of data we publish, ensures that RateSetter continues to lead the way in providing investors with accurate and transparent information.