P2P Lending with buyback guarantees: advertising without added value?
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Although you have intensively researched P2P loans as an asset class, read various books and registered on your first P2P platform, one question still remains. Can I really rely on the buyback guarantee that so many platforms advertise?
Is it justified to have doubts? A guarantee is a commitment, after all. Let's take a look at how buyback guarantees work and clarify whether a buyback guarantee truly is more than just an advertising promise.
Buyback guarantees made simple
Under a buyback guarantee, a credit company agrees to repurchase a loan if the borrower fails to make loan payments on time (default). The loan company does not only recover the investors' invested capital, but also pays them the interest they have lost. Typically, loans are repurchased after they are 60 days late.
You have probably noticed that the buyback guarantees are not offered on all platforms. The buyback guarantee is only offered on P2P platforms that act as a marketplace to broker loans between investors and loan originators (lending companies).
In this respect, you must understand that it is not the platforms that provide the guarantee. The buyback guarantee is offered by the loan originators.
At first glance, the buyback guarantee is a positive thing for all parties involved. Investors don't have to deal with troublesome loans, as they will always be guaranteed payment.
This creates a sense of security, which attracts more investors to the platform, which the platform operators are happy about.
Even loan originators benefit from the buyback guarantee. After all, once they have bought back a loan, they can earn further fees during the debt collection process when recovering the outstanding payments.
How is a buyback guarantee financed?
Buyback guarantee costs are (indirectly) financed by investors.
For example, if a loan originator grants a loan with an interest rate of 20%, it is very frequently offered on the platform afterwards at half of the interest rate, in this case about 10%.
There are no reliable figures on the share of interest used to finance buyback guarantees. Estimates suggest that between 10% - 20% of interest is used to finance the buyback guarantee.
That is the (hidden) price that investors pay to be able to pass on the default risk to the loan originator.
The risk of buyback guarantees
Those taking a closer look at buyback guarantees will rapidly ask themselves: What's the catch?
Generally speaking, a guarantee is only worth as much as the reliability of the guarantor.
What this means in practice is that the value of buyback guarantees depends on the creditworthiness of the loan originator.
For instance, guarantees from a loan originator that is at risk of bankruptcy themselves are not worth much and are almost equivalent to an empty promise.
Unfortunately, this risk has already materialized on several occasions.
If the loan originator goes bankrupt, you can assume that there will be a total loss of your investments with this loan originator.
These platforms will try to ensure that you get at least some of your money back by negotiating with the loan originators and even taking legal action against them. However, past cases have shown that proceedings are lengthy and investors should not have high expectations of getting repaid.
Buyback guarantees on Mintos
Mintos is currently the largest P2P platform in Europe (January 2021). In recent years, Mintos was able to outperform all other platforms with its rapid growth.
Mintos pursues the P2P marketplace business model. The platform does not broker loans directly, but mediates loans between loan originators and investors.
Most loans (more than 90%) on Mintos are brokered with buyback guarantees. Investors can specifically only invest in loans with buyback guarantees.
Experiences with buyback guarantees on Mintos
As the largest European platform, Mintos is very well suited for taking a look at the past.
Unfortunately, compared to other platforms, there have been relatively frequent bankruptcies of loan originators on Mintos. The comparison is flawed, however, because the larger the platform is, the more loan originators grant loans on the platform. The more loan originators there are on the platform, the greater the probability of bankruptcy. We therefore cannot conclude that there are more or fewer loan originator bankruptcies on Mintos than on other comparable platforms.
Among the most well-known bankruptcies on Mintos are those of the following loan originators: Eurocent (2017) and Aforti Finance (2019).
Aforti Finance bankruptcy
Initial troubles with the loan originator Aforti Finance from Poland were announced at the beginning of 2019. Mintos shared on its blog that the platform had reached an agreement with Aforti, suspending the brokerage of new loans on the platform.
As a result, Mintos also lowered Aforti's rating (a measure of the loan originator's creditworthiness). Some investors have criticized the fact that the rating downgrade did not coincide with the announcement that the granting of new loans would be suspended for the time being.
In August 2019, Mintos informed investors that Aforti was not fulfilling its obligations to make payments. Subsequently, Aforti was excluded from the platform. Aforti resumed payments in September, but stopped them again in December.
According to Mintos, the negotiations with Aforti continue. Investors are waiting for their money, and we have to assume that they won't see a large portion of it again.
We wanted to clarify whether P2P lending with a buyback guarantee provides investors with true added value.
A buyback guarantee adds value to investors by enabling them to pass the credit default risk to the loan originator. Investors do not have to worry about collecting late loan payments.
However, we believe that the term alone provides a false sense of security to investors. Another appropriate term should be chosen to describe the actual process behind buyback guarantees. Additionally, it should transparently describe that the risk is only transferred to the loan originator.
Just as loan defaults are part of P2P lending, so are the bankruptcies of loan originators.
Under no circumstances should you rely on the buyback guarantees of loan originators.
Instead, we recommend that you spread your investments in P2P loans over as many loans and as many loan originators as possible.