Analysis Featured

Funding Circle Review

Funding Circle is a peer-to-peer lending (P2P) platform where investors can lend money to small to medium (SME) sized businesses. Founded in 2010, Funding Circle has grown into the largest business-focused UK peer-to-peer lending platform.

Investors have the choice of manually selecting the businesses they wish to lend to, or they can automatically invest across a large number of businesses using the Funding Circle  “Auto-bid” function. Loans are split into a minimum of £20 chunks or loan parts allowing investors to achieve a high level of diversification when investing relatively low amounts. Funding Circle suggests lending to a minimum of 100 businesses to achieve a 1% exposure to any one business. When investing a minimum of £2,000, Funding Circle’s auto-bid function will achieve this level of diversification automatically.

Borrowers across Funding Circle are all small- to medium-sized businesses (SMEs), borrowing between £5,000- £1 million for loan terms of 6 months to 5 years. Borrowers operate across a range of sectors and the reason for borrowing varies. In 2014, Funding Circle extended its lending to residential and commercial property developments, however, in April 2017, it was announced that lending to property-related borrowers would stop, allowing the company to remain focused on SME lending.

Funding Circle is the only peer-to-peer lending platform of scale which operates across multiple geographies. The P2P platform has expanded from the UK to the USA, Germany, and Spain. 74% of Funding Circle’s group (Funding Circle Holding Limited) revenue in the period ending the 31st December 2015 came from its UK business (Funding Circle UK Limited). It’s important to note, UK investors are solely exposed to UK businesses when investing through the Funding Circle UK platform. To support the global growth of the Funding Circle group, the company has raised equity investment totaling $414 million from venture capital investors including Baillie Gifford, Blackrock, Index Ventures, and Accel Partners.

Investors may also invest in loans assessed by Funding Circle through the Funding Circle SME Income Fund, a listed Investment Trust. For more information on the Funding Circle SME Income Fund, please visit: http://fcincomefund.com/.

This review focuses on lending funds directly across the Funding Circle platform.

Investment Products

Investors can open an account directly on the Funding Circle website, deposit funds, and either select the Funding Circle Auto-bid function or manually select the borrowers they wish to invest in. Financial advisers cannot currently open an account on behalf of their clients. Investors must invest directly.

Funding Circle Products
Auto-bid Manual
Advertised Rates (annual) 7.10% 4.4%- 9.2%
Terms The autobid functionality allows investors to invest automatically in a large number of businesses. This is a low maintenance method of investing across Funding Circle. Investors can manually select the businesses they wish to lend to. Funding Circle grade each loan between A+ to E and provide a substantial amount of information on each borrower, including financial statements. Investors can further communicate directly with the borrowers.

Investors can select existing loan parts being sold on the Funding Circle secondary loan market or invest in new loan parts.

The autobid advertised rate is an estimate based on the projected performance of the 3000 most recent loans. It is the gross interest rate minus a projected bad debt rate estimate and minus a 1% annual service fee.

Withdrawing Funds

During the loan term, investors will receive interest and principal repayments. If investors want to withdraw their investment at no cost, they will have to wait until all repayments have been made. Default settings assume that capital and interest payments are reinvested into other loans. To withdraw funds early, investors must sell their loan parts to other investors on the Funding Circle secondary market. Funding Circle charges 0.25% to sell loans parts on the secondary market.

The secondary market is very active with investors buying and selling loan parts. The selling of loan parts allows investors to liquidate their investments into cash and withdraw funds. Investors can also buy loan parts inline with their particular investment strategy.

Investors are able to buy and sell loan parts at a premium or discount of 3%. If investors wish to sell loan parts and access their funds quickly, they could offer a discount.

Net Returns

To estimate net returns, Orca has conducted loan by loan cashflow analysis on every loan originated by Funding Circle. An accurate estimation of actual net returns can be made for the years where 100% of loans have completed. As the maximum loan term on the Funding Circle platform is 5 years, loans as far back as 2012 are still in circulation and therefore at risk of default. As the years progress, the percentage of assets (loans) under management increases, and the accuracy of net returns estimates decreases.

The chart below assumes that all loans still in circulation completed as planned with all repayments made (no default estimation has been applied). The actual net return will therefore be reduced as loans progress through their term.

Funding Circle net returns

With the exception of 2011 where the net returns have been estimated to be 4.11%, the Funding Circle net returns have been consistently above 5%.  The net returns appear to be rising in 2015 and 2016, however this is a reflection of the large number of loans still in circulation.

Default and Bad Debt Performance

Again, we have plotted the assets under management against the default and bad debt rates.

FC bad debt, default rate

NB: A loan is considered defaulted if three consecutive payments have been missed. Bad debt includes any recoveries.

By comparing Funding Circle’s default rate relative to its bad debt rate, we can see the performance of the company’s recoveries process. Although the default rate has been relatively high, 7.46% in 2011, the Funding Circle recovery process appears to be effective, reducing capital losses to 4.96%.

The Funding Circle collection team pursue any missed payments. If a business ceases trading and has a personal guarantee attached, Funding Circle Trustee Limited will attempt to recover the maximum amount possible as a creditor of the business.

Volumes

Funding Circle has originated over £2 billion worth of loans since the company was founded in 2010. In 2016, Funding Circle facilitated £823 million worth of loans, equating to a 26% market share. The largest of any UK P2P provider.

FC investor type breakdown

In the past four years, we have seen significant capital on the Funding Circle platform come from institutional investors (54% in 2016). Institutional investors include Funding Circle’s investment trust, ‘Funding Circle SME Income Fund’; Marshall Wallace’s investment trust, ‘P2P Global GI’; and the investment trust ‘VPC Speciality Lending’. The British Business Bank also lends through Funding Circle as a means of supporting SME businesses.

Loans on the Funding Circle platform can be categorised by geography and loan type, and the platform grades the loans A-E*. Investors who choose to manually select their borrowers have the flexibility to form lender strategies and select different loans in specific categories. Orca has calculated default metrics and lending volumes for different categories. You can find this information by signing up to the Orca platform. It’s free until September 2017 and can be accessed via the link below.

If we focus on 2015, where 61% of Funding Circle loans are closed (completed or defaulted), we can see that Business Expansion is the primary loan purpose on the Funding Circle platform. Defaults are highest for loans categorised as ‘other’ (4.80%) and working capital (4.59%).

loan volumes and default rate by loan purpose

Again, taking 2015 data into consideration, we can see that default rates are highest in Wales (5.56%) and Scotland (4.80%). Lending is spread across all UK geographies.

loan volumes and default rate by geography

Security

The majority of loans on Funding Circle are unsecured; the directors of some borrowing companies may provide personal guarantees, however.

Asset security is also a requirement for some borrowers, particularly when the purpose of the loan relates to property lending.

Diversification is the principal risk mitigation method Funding Circle offers. When lending to a large number of borrowers, if one fails to repay their loan, the overall impact on the portfolio will be low.

Borrowers

Funding Circle borrowers are all SME businesses, borrowing between £5,000- £1m for a period of up to 5 years. In 2014, Funding Circle started facilitating loans to property developers, increasing the lending cap to £3m. Property related loans accounted for 18% of the loan book in 2016.

Borrowers are assessed using the Experian Delphi Score and the company Financial Statements. The loan purpose, borrower profile and any security offered are also taken into consideration. For non-limited companies, credit scores are taken from CreditSafe.

The weighted average borrower rate, net of fees, shown below, has increased from 7.98% in 2010 to 9.34%. This is not considered a drastic change and indicates that Funding Circle has remained consistent with its core lending criteria. The spread of lending rates between the minimum and maximum has, however, increased from 2010 to 2017.

weighted average borrower rate

Similarly, the average loan size has increased from £29,150 in 2010 to £73,129 in 2019. The introduction of higher value property loans in 2014 may have influenced this trend to higher value loans.FC weighted average loan size

Overall, from reviewing the weighted average borrower rates and loan amounts, we can see that Funding Circle is widening its lending criteria, but generally keeping to the core lending principles.

Conclusion

Funding Circle is rapidly evolving into the largest UK P2P provider in the UK by loan volume. With such a large volume of loans being originated by Funding Circle, the liquidity of its secondary market has grown so that investors can gain access to their funds early; a reassuring and potentially attractive prospect for investors concerned by the illiquid nature of peer-to-peer lending more generally. Staying strongly aligned to it’s core lending of SME businesses, Funding Circle is able to continually develop it’s loan originating capabilities and refine it’s credit assessment processes. An increase in institutional capital on to the platform, as well as the landmark securitisation of loans in 2016, have served to firmly establish Funding Circle as a global leader in the P2P industry. 2017 onwards will be telling, to see if Funding Circle and other major peer-to-peer providers can advance the asset class into the mainstream.

For more analysis on Funding Circle and other P2P providers, sign up to the Orca platform, which is free until September.

Author:

Written by Iain Niblock, CEO of ORCA.

Iain Niblock, ORCAOrca aims to drive the mainstream adoption of peer-to-peer lending (P2P) by providing the research, analysis and tools to empower investors. The Orca platform, launched in spring 2017, allows financial advisers and investors to perform in-depth due diligence on P2P investments. Independent data analytics is at the core of the Orca proposition allowing advisers to make risk adjusted investment recommendations.

Iain Niblock has been involved in Alternative Investments for three years. Prior to Orca, he founded an investment company which raised and lent capital via a listed retail bond. Before his entrepreneurial endeavours, he worked as an Economist and Analyst at Centrica PLC.’

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