What is debt crowdlending or crowdfunding?

June 22, 2020

The opinions of the employees of s You are personal.

What is debt crowdlending or crowdfunding?

Platforms Crowdlending (or debt crowdfunding) have increased in our country and offer many people interesting investment alternatives.

In this article, I will focus on investors who participate Debt crowdfunding;; that is, those who lend capital and expect to receive interest / returns on their investment.

1. Understand the loan rate

In most cases, the platforms display the credits at their annual rate. For example as follows with annual rates of 21.9, 23.9, 28.9 and 18.9 percent.

This rate corresponds to the rate that the applicant pays for his credit. However, it is important to understand that this annual rate only applies to unpaid credit. For example, if you lend 10,000 pesos at an interest rate of 21.9%, you will receive interest at the end of the first year (\$ 2,190 + VAT) only if a single payment was made at the end of the first year because the 10,000 pesos was yours Capital remains borrowed year round (\$ 10,000 x 21.9%). However, platforms usually charge monthly credits so that you receive a portion of your capital and the corresponding interest every month.

Since you receive part of your principal each month, the money is not borrowed all year round, so the gross interest you receive is lower (around \$ 1,233 + VAT). In this way, when calculating the performance of previous payments, taking into account the monetary value over time (ie taking into account monthly payments and not just 1 at the end of the period), a return of 21.9% is achieved. This value is called internal return (in Excel, the formula is “IRR” or “IRR” if your Excel is in English).

Now it is important to take into account that this achievement will only be achieved if the credit is paid out on time.

2. If the credits are too late

In the case of a borrower, your benefit may be even higher if the credit is delayed (but eventually paid) because the standard credit interest rate is calculated (in our case 10% above the interest rate). ordinary) is for our investors. Some other platforms may not have default interest rates in favor of investors. Therefore, pay attention to what treatment the platform you are investing in offers.

It is assumed that the standard interest is only calculated on the overdue balance of the loan (capital + ordinary interest), since the debit of the unpaid balance or the consideration of late payments for late payments (called anatocism) is abusive and illegal. In most cases, this interest is calculated and increases daily to the overdue amount as long as the loan is not up to date.

3. Overdue portfolio

The overdue portfolio is the biggest impact on an investor’s performance. However, it is important to mention that each platform has defined the overdue portfolio based on its own criteria. At Prestadero, we follow the accounting criteria set out by the CNBV in the bank circular.

It is stipulated that credits with regular interest and principal payments must be considered past due if the credit is overdue for 90 days or more. The longer the platforms are used, the more relaxed this criterion becomes. For example, if the criterion is overdue for 180 days (by the way, I don’t know of any platform that takes this into account, it is only for illustrative purposes), your credit can only be reported as an overdue portfolio 210 days after the loan is released. (taking into account the fact that the first monthly payment is not paid (30 days) plus the 180 day delay of this criterion).

If a loan you borrow is overdue for 90 days or more, it will appear on your profile as a loss or overdue, reducing the value of your account. The reduced value is not only the overdue amount, but also the capital or the total outstanding capital of the loan.

For example, suppose you borrowed \$ 1,000 in a 12-month loan where the applicant made 8 monthly payments and stopped the 9th monthly payment:

Around July 25 (90 days after monthly payment 9 is due), you have an overdue amount for this loan of \$ 359.90 (total of monthly payments 9 to 12) because, even though you loaned \$ 1,000, have already made monthly payments 1 to 8 with their respective capital and interest.

It is important to mention that this loss is “not realized” since the collection work will continue, although the possibilities to recover the loan are reduced. In the case of the borrower, this can lead to the credit being withdrawn (late or even short-term) and / or continue to be paid even if the status remains overdue (if the partial payments made are insufficient to collect the expired status). If a credit is overdue for 4 monthly payments and the applicant makes half a monthly payment, it is still largely overdue (as the backlog does not change because its oldest monthly payment is still 50% overdue), but if so If you pay the full monthly payment, you can switch to the “Delinquent” status because you are only 60 days past due. This means that the amount that is deducted as overdue is no longer deducted and the value of your account increases.

4. Restores

However, if a loan is recovered as soon as it is overdue, a special agreement has already been made to claim back as much as possible (in or out of court). The amounts are called recoveries. In other words, the balance remains due, but the payments are credited to your investor account until the agreed agreement is concluded.

In the case of a borrower, this happens if we carry out an express plan that deviates from the original payment plan (but no refinancing) and / or if we make an asset allocation based on a court decision in favor of our investors. Once a loan is overdue, you can:

1) continue to receive payments on the balance applied to the original payment schedule, or

2) Receive payments as a refund.

5. Power calculation

Pay attention to how the performance is calculated on the platform. Make sure that the return is a real return (taking into account payments, interest, overdue portfolios, commissions …) and based on real flows. It is important that you do not consider your performance as expected (e.g. a simple average between the interest rates of the loans in which you have invested). In the borrower, the return is referred to as REPA (Annual Borrower Return). However, it is nothing more than the calculation of an IRR, in which we consider positive flows: (+) ordinary interest without VAT, (+) default interest without VAT, (+) principal payments, (+) reclaims, (+) that in the last period considered outstanding capital (and deduction of the overdue portfolio); and as flows that negatively impact this performance: (-) total commissions with VAT and (-) credit financing.

It is also important that you check whether the return calculation is annualized (or whether it relates to the total term of your investment). In the case of Prestadero, it is annualized to facilitate comparison with other instruments.

It is also important that you exercise caution about returns in the first few months of your investment, as this can be very volatile in the short-term annualization of a calculation. That is why in Prestadero we only show you this service from the third month of your investment.

6. Maturity of the portfolio

Has it happened to you that the initial return on your crowdfunding investment is high, but after a while it corrects downwards? This setting is normal, but it is important to understand why this is happening. Investors often believe that applicants’ selection criteria have worsened, but this is rarely the case. Rather, it is a portfolio maturity problem.

Let’s say you start investing in a platform in January. Do you know what your expired portfolio will look like in April of the same year? I make 0% of the overdue portfolio, regardless of which platform you invest in and which selection criteria apply. Why? Since the first payment of the loans you lent in January is in February and April, even if no loan is paid, they are only 60 days past due, so you cannot have an overdue portfolio (90 days). Do you remember that I told you that the most important impact on performance is the overdue portfolio? For this reason, very young (immature) portfolios start with high returns. Even if the criteria of the platforms you invest in take into account the overdue portfolio for 120+ or ​​150+ days, this concept is even more important.

The following graphic from the Lending Club (one of the largest platforms in the United States) illustrates this concept.

In your historical 36-month loan numbers (x-axis), you will find that yields (y-axis) start high and then correct themselves downwards, with the largest decline between payments 5 and 15 and itself then stabilized. To determine your true performance, you have to wait until your portfolio is mature.

It is very important to understand this concept in order to measure your performance expectations. Let’s take the example of the following portfolios or portfolios of an investor, portfolios 1 and 2:

Both have an overdue portfolio of 5% (red) and both have a default of 2% (yellow). Which portfolio do you prefer? Despite the fact that both have the same overdue portfolio, you should have portfolio “1” as it is a mature portfolio. In both portfolios, only what is yellow (delinquent) and blue (current) can be overdue. So Portfolio 2 has a much bigger potential for increasing the overdue portfolio. What is green when it is paid is already set in stone and can no longer migrate due.

If you stop lending on a platform and mature your portfolio (everything happens to be paid or expired), this is the only way to determine your actual performance. But you can also do another exercise to get an estimate and it’s about getting your own harvests. So check the overdue percentage of your credits, but only those that are overdue that were released in a given year or month.

For example, if you calculate your overdue portfolio of 36-month loans published in 2019, this calculation won’t help you much (because if published in 2019, they will complete payment in January 2022, a date that still exists , even if they were published in January does not expire). Even worse if you get it for loans you lent in 2020. However, if you calculate your overdue portfolio for, for example, 36-month loans published in 2015, you can already estimate your overdue portfolio based on a mature “harvest”.

If you continue to lend on a particular platform and use the overdue portfolio as global data (with your percentage paid still low), your apparent (immature) overdue portfolio will be lower than the final (mature) portfolio.

In general, on the platforms, you can export the details of your loans to Excel to do your own analysis.

Keep in mind that if you only invested in 10 or 20 credits, you will have little representative information. I recommend doing this exercise only if you have invested at least 100 credits. If your portfolio is highly concentrated (e.g. you have 100 loans, but you have invested 80,000 in one and the other 20,000 in the remaining 99 loans, it is more difficult to estimate a representative number).

7. Calculation of overdue loans

Platforms generally calculate overdue loans somewhat differently than banks or financial companies. We do this because the business model is different, and we want to show you overdue portfolio data that can be interpreted fairly. Banks or financial companies generally view their overdue portfolio as: (overdue balance) / (portfolio balance in the period). Instead, platforms generally consider: (total overdue – repayments) / (total borrowed). Many users ask us why we don’t consider the same base, that is, the amount due as a percentage of capital or outstanding capital, and not over the total. Overall, the difference is that banks or financial companies, when lending their own funds, can “punish” their overdue portfolio by estimating it as a loss and lowering the meter. For example, if a bank’s overdue portfolio is 5,000 pesos, it can consider it a loss on its income statement and provide data about the overdue portfolio or the 0% “default rate”. This does not mean that they actually did not have an overdue portfolio, but that they already considered it a loss.

Instead, the platforms cannot “punish” the overdue portfolio and decrease the counter because the portfolio belongs to our investors. For this reason, we look at the overdue history (minus the restored one) in the borrowed history to provide you with more useful information.

If you are still discussing this point, let’s take an example. Let’s say you invest in a crowdfunding platform with 100,000 pesos and stop lending to make your portfolio mature. For example, suppose you only have 1,000 pesos outstanding in one of your loans and the overdue portfolio for your entire investment was 2,000 pesos.

If we do the calculation suggested by the platforms, your overdue portfolio will be \$ 2,000 / \$ 100,000 = 2.0%. Conversely, if we use the calculation used by the banks, your overdue portfolio will be \$ 2,000 / \$ 1,000 = 200%. It makes no sense? In fact, you have “lost” only \$ 2,000 (2%) of the \$ 100,000 you borrowed.

8. Conclusions

Investing in crowdfunding was an excellent alternative to get very attractive returns in an asset class that was previously unavailable to people with limited resources. In addition, the level of diversification that technology has enabled can limit the risk of these investments. Regardless of what you invest in, it is always important to understand as much as possible about your investment. I hope this article has helped you to understand a little more about the operation of crowdfunding platforms for debt and thus about the investment you have made with us.

Disclaimer: The opinions and concepts presented here are their own and are not intended to encompass or standardize the treatment that the platforms perform for their investor customers. The concepts are based on my experience as the founder of Prestadero and on the operation of our own platform.