5 Things to consider when investing in P2P

www.landbay.co.uk @LandbayUK
Top 5 Things to be Considered
When Investing in the Peer-to-Peer Space
Julian Cork, COO, Landbay

Intro: Landbay

Intro: Where we are to date

Intro: Risk
Do you understand the risks you are taking?
Are you being appropriately compensated for this risk?
The way you asses the answers to these two questions is different within the peer-to-
peer space to their assessment in conventional lending. There are five key factors
you need to look at:
1. Borrower
2. Asset
3. Transparency
4. Performance
5. Platform

1. Borrower
Firstly, it is important that you understand exactly who you are lending to. This is both
about understanding the fundamentals of their credit footprint and well as understanding
why they are borrowing on the platform. What were their other options? Why are they
not borrowing from conventional sources such as banks? It is also important to
understand what they are borrowing for and ensuring that it is in their interest to repay
the loan.
A good way think about this is to consider the 5 Cs…

(i) Character: Understanding the borrower and their credit file. At Landbay we use Equifax to
look at credit history and Jumio to validate identity, enabling us to complete ‘KYC’ checks.
(ii) Collateral: Being clear about any assets underlying the loan and confident about the legal
status of this security. Do the platform’s terms & conditions articulate this? Does the platform have
appropriate charges against the security?
(iii) Capacity: Ability to repay. What is their income? In a property deal, do they solely rely on
rental coverage? How does the platform validate this? At Landbay, borrowers need a min. income
of £30,000 alongside 125% rental coverage. These facts are externally checked using surveyors,
market analytics and bank statements.
(iv) Capital: Do the borrowers have skin in the game? In property this is all about LTV.
Landbay’s average LTV is currently 63.1%. Be sure that if you are financing someone’s car they
have a high enough proportion of capital in it to stop them from simply walking away.
(v) Condition: Taking into account the factors above, are the loan amounts and rate
appropriate for the borrower? If the interest rate accepted by the borrower is too high do you know
why? Ask yourself what you are missing.

2. Asset
There are a wide range of loan types available to potential
peer-to-peer investors. These fit broadly in three categories:
Consumer, Business and Property.
Consumer:
• Car
• Credit Card
• Home improvements
Business:
• Secured
• Unsecured
Property:
• Development
• Bridging
• Commercial
• Residential Buy-to-Let

Ensure that you understand if the loans are secured and if so, how formally.
Someone borrowing against a car or new kitchen may have that asset against the
loan but recovery is going to be through normal, personal loan channels as it may
not have been formally or contractually secured.
The most common secured lending is property, the credit procedures around
mortgages are mature, tested and well understood.
You need to understand what type of property loans you are dealing with. Not all
are equal. Each type of property lending comes with its different risks.
Secured Lending

UK Commercial vs Residential
Averagepropertyprice
index
Source: Nationwide, IPD

This graph shows a comparison of value between commercial and residential
property baselined at 100 in 2002. As you can see, both residential and
commercial property values dropped during the credit crisis, but by significantly
different values.
When considering commercial property vs residential it is important to remember
that the way in which people work/shop is changing. However, people will always
need a roof over their head, regardless of the economic cycle.
During 2007, commercial property values dropped right back to 2002 levels,
whereas residential maintained its 55% increase.
UK Commercial vs Residential

BTL Mortgage & Rent Arrears
Numberofproperties
Source: LSL

At Landbay we focus on buy-to-let mortgage lending as it is a large market that allows
us to scale significantly. Annual lending was £27bn in 2014, which is well off the peak
in 2007 of £44bn. It is anticipated to hit c. £31bn this year (2015).
Residential BTL mortgage lending is historically a very low-risk form of lending. Even
during the stressed periods between 2009 & 2012, tenant rental arrears increased by
about 75%. During this time BTL mortgage arrears roughly halved – and as per the
previous graph, average residential property prices fell by c. 18%. Note that most of
the losses were in large new developments in city centres outside London.
The picture here with rent arrears increasing and BTL mortgage arrears decreasing
demonstrates the asset’s performance in tough times and highlights the importance of
understanding those ‘Cs’ we spoke about earlier – capacity to repay and capital.
BTL Mortgage & Rent Arrears

UK Average Quarterly Rents
AverageQuarterlyRent
Source: Office for National Statistics

One of the main reasons for buy-to-let’s strong performance is the resilience of the
cash-flows that service the debt. Average rents have risen steadily throughout this
period and only fell by a few percent in 2008.
In fact it is difficult to spot the credit crisis in this graph!
As a matter of interest average rents have broadly risen in line with inflation
(1.5-2%) per annum which does beg question as to why some politicians feel the
need for rental controls….
UK Average Quarterly Rents

3. Transparency
Loan Book; are they hiding anything?
Landbay was the first UK P2P platform to make their loan book publicly available back in
2014. Some others now show theirs, but mostly only once you have already become a lender.
Platform’s cut; can you work this out?
Do you understand the rates?
Are they transparent about the risks involved?

Risks
FSCS: Lenders and borrowers on all peer-to-peer platforms, including Landbay, are not
currently covered by the Financial Services Compensation Scheme. P2P loans should be
considered as loan investments, not deposits.
Liquidity: How accessible is your capital? Is there is a risk that you cannot access it? Is
the platform transparent about this? What happens when loans are paid off early?
Due Diligence: Slide 6 covers the five “Cs” – be sure that you know how platforms
complete the Due Diligence. This should include comprehensive identity, fraud and credit
checks on the borrower and independent professional valuation on the underlying security
(property or asset).

Risks cont.
Platform Failure: In the peer-to-peer world it is particularly important to understand
what happens if there is a platform failure. Are client assets in segregated client accounts?
Has the platform complied with CASS 7 FCA client money rules? And have appropriate
procedures been put in place with administrators to continue operations should a firm hit
insolvency?
Landbay ring-fences unlent funds on lenders’ behalves in trust in a segregated bank account
with Barclays PLC so they do not form part of our assets (and would not be available to our
creditors in the event of our insolvency). The security charge over properties is also held in
trust for the benefit of lenders.
Our third-party loan administration contract is structured to ensure the ongoing margin from
our mortgages is sufficient to cover the costs of administering them during any winding down
process, should Landbay cease trading for any reason.

Risks cont.
Defaults: Understand how missed payments will be pursued and how any provisioning
fund works. Be clear on when a missed payment moves to a formal default and how a
platform deals with this. At Landbay our Security Trustee will move to repossess a property
on behalf of the lenders, in order to expedite the return of capital or implement direct rent
collection. In the established world of BTL mortgages these are both well understood
processes.
Diversification: Is your investment diversified over a number of loans? Can you easily
understand the loan parts that you are in?
Many platforms are committed to transparency and for members of the P2PFA it is a
mandatory. Every investor on every platform is taking some risk. They must understand that
risk and be compensated for it. Platforms must be open and educate their users. Platforms
can’t operate like quasi collective investment schemes without being clear who they lend to.

Landbay’s Lending Statistics
Like a few other platforms, we publish our key lending statistics at
Landbay to show lenders the diversification, security and income
coverage for our loan book as a whole.

Our Full Loan Book
Landbay also publishes a full,
more detailed loan book.
We itemise the individual
rates (both borrower and
lender) as well as the
additional detail about the
underlying security (value,
LTV, rental coverage,
location).
We clearly articulate the split
between our “retail” peer-to-
peer loans and our
institutional loans.

4. Platform
It’s easy to make a slick looking website but you need to be able to have a
look under the bonnet. Understand who is running the platform and
how they are doing it. Look at the following components:
• Executive Team and Board
• Innovation
• Customer Service
• Will loans continue to be serviced if anything were to happen to the platform?
• Business model
• FCA regulation
• Trust

5. Performance
Theory helps you to make informed decisions about investing,
and we have spoken about understanding the underlying assets
and borrowers. It is also important to look at historic
performance of both the platform and asset class.
That means understanding expected default rates and actual
default rates. All members of the Peer-to-Peer Finance
Association are mandated to show these on their site in
a consistent fashion.
You also need to understand what the platform does with these statistics; how are
they planning to deal with defaults?

Default Rates
The first thing to consider here is the accuracy of the projected default rates. How
have they been modelled and do they consider more macro-economic factors?
Stress tests help to understand a portfolio’s behavior as, for example,
unemployment rates rise or house prices fall. Established markets such as
housing have many solid data sources to help here such as the CML (Council of
Mortgage Lenders). Make sure that you check sources cited.
Landbay’s default rates:
* Actual arrears (as a % of all outstanding balances
from loans made in the calendar year of the loan)
** Expected defaults (as a % of all lifetime default
rates of amount lent in the calendar year of the loan)
*** Actual defaults (as a % of the total lent by the
platform in the calendar year of the loan)

Stress Tests
Look to see if these stress tests have been done, to what standard and if they are publicly
available. Landbay was first UK platform to publish stress tests of our loan book in our
Democratising Mortgage Lending Report and we are in the process of conducting more, to BoE
standards. These will be published in the coming weeks. Funding Circle have also recently
conducted stress tests.
Provisioning
Another credit enhancement mechanism found in some platforms is the concept of
provisioning. At Landbay we have our Rainy Day Fund. It is important to understand how much
is being put into this fund and if it reflects the stress testing and expected default levels. You
can look at any provisioning fund as a % of loan book and compare this with historic
performance. It is however important to remember that these are in no way ‘insurance
products’ and allocation of any provision fund’s money is solely at the discretion of the
platform.
No investor should rely on a finite amount of funds for the protection of their capital, especially
as P2P investments are not covered by the FSCS.

Summary
Understand the
risks you are
taking &
ensure you are
appropriately
compensated
Borrower
Performance
Transparency
Platform
Asset

And finally…
Remember that people tend to not lose money on bad risks – they
don’t put money on these.
People lose money on good risk that goes bad – so the five factors
explored in this presentation need to be continually re-assessed
throughout the life of your investment.
Thank you

info@landbay.co.uk @LandbayUK
www.landbay.co.uk

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