Last time, I wrote to you about how we use our vast stores of information in risk analysis. This time, we’re going to take a look at Safeguard, how it’s funded, what its purpose is, and what it can and cannot do.
The Safeguard Trust
If you choose to lend in Zopa Access or Classic your investments are covered by our Safeguard fund. Note: covered, not protected. Safeguard shouldn’t be seen as a guarantee of your investment.
- Safeguard covers expected losses our lenders may see during a normal economic environment (i.e. not in a recession and with unemployment rates holding steady).
- When it was launched in April 2013, Safeguard was also introduced as a tax efficient way to offset bad debt against interest earned on loans. Now that HMRC have updated their guidelines, lenders can make a claim for tax relief on losses directly (as of April 2015).
How it’s funded and when it pays out
As part of the borrower application process, Zopa takes an upfront fee: and part of this goes into the Safeguard fund. As part of their repayments borrowers also pay a monthly fee, and again some of this goes towards Safeguard. We aim to maintain Safeguard at 1.1x what we expect to pay out (currently it is at 1.2x).
Should a borrower default (they reach 4 months’ worth of missed repayments), Zopa will step in and administrate the loan. Now, if your loans are covered by Safeguard, a claim is made for the outstanding loan amount and missed interest. In almost all circumstances, the fund will pay both the missed interest and the outstanding capital.
The chart above shows how Safeguard is likely to perform under different economic conditions. Here, you can see that in a relatively steady economy Safeguard functions as described earlier in this post. Should an event occur that disrupts that stability, and causes default rates to rise to 3%, then Safeguard will begin to feel the strain and be unable to fully cover this amount of defaults: meaning lost interest and net yield for lenders dropping to 4.5% (from 4.8%). Above 10% (i.e. 5x over our expected default rate), some capital would be lost. To add some context, during the 2008 recession, actual losses increased x1.62 above expected default rates: in today’s world that would mean our expected defaults went from 2.3 to 3.7%.
Zopa Plus lenders aren’t covered by Safeguard: they take on more risk for higher returns. Zopa will still work to recover the money owed, with all recoveries going directly to the lender.
Since we introduced Safeguard, all claims have been paid; but there’s no guarantee this will always be the case.
Sharvan Selvam is Head of Risk at Zopa.