Since 2010 the UK has seen continually improving consumer credit performance leading to historically low levels of bad debt.
In early 2016, we at Zopa started to see some early signs of a possible change in this trend. It now looks like the change is real:
- Publicly available data suggests consumer default and insolvency levels are reaching levels which are more consistent with historic norms prior to 2010; and
- The Bank of England in their credit conditions survey stated “Lenders reported that default rates on both credit cards and other unsecured lending to households were reported to have increased significantly in Q2 [of 2017].”
While we are not immune to this industry-wide trend, the impact on lending at Zopa is limited. This is because we identify and focus on low risk borrowers, we have been cautious in our underwriting in anticipation of increases in default rates, and, since early 2016 in response to very early indications, have been more and more cautious in our lending criteria.
More recently, we have reduced the amount of lending in our higher risk, higher return D-E markets (which are included in the Plus product). We are also taking steps to attract more lower risk customers, thus increasing the proportion of A and B-rated loans.
What this means for new investments
As a result of the increasing proportion of lower risk, lower return loans we expect to approve, we are expecting a lower targeted return of 4.5% for new investments in Plus. Similarly, the targeted return for new investments in Core will be 3.7% reflecting a shift towards lower risk loans in the A-C markets.
It is important to note that the target average return levels for new investments in each risk market (A–E) have not changed materially. The change in overall return is a result of changes in mix. For example, the proportion of D and E loans in the Plus product would go from 30% until now, to 10-15% in the future.
What this means for existing investments
For existing loans, we are expecting slightly higher losses. For existing investments in Safeguarded loans, we expect no impact on loans as Safeguard coverage is expected to remain above 100% (including future contributions).
In addition to changes in loss expectations, we are also seeing an increase in early repayments from borrowers. While this means that investors get their money earlier, it also reduces interest income and thus returns.
If these trends in early repayment rates and credit losses continue, we would expect that for existing investments in non-Safeguarded loans originated up to August 2017, realised returns will be lower than original expectations: 3.5% compared to 3.9% in Core and 5.6% compared to 6.3% in Plus.
As ever, we publish our loss expectations for existing loans on our website, and how that evolves as the loans mature. This information, available here, is updated monthly, and is used to update your personalised projected returns.
So, along with the loss expectations that we refresh each month, we will publish a blog post giving an overview of what’s happening in consumer credit. We’d also like to hear and answer your questions in that post. Just email us at email@example.com and we will be delighted to answer the common themes in that monthly post.