17 minute read
Hadi Habal on opportunities in private credit
Opportunities in private credit
HCG Funds founder Hadi Habal speaks to Marc Shoffman about the alternative investment manager’s allocation strategy
INSTITUTIONAL INTEREST
in fintech lenders – including peer-to-peer lending platforms – is on the rise.
One player in this growing market is HCG Funds, an alternative investment manager that specialises in backing private credit originated through fintech platforms.
It was set up in 2010 by Hadi Habal and Jose Penabad, who used to work together at investment bank JP Morgan.
The fund doesn’t publicly comment on the platforms it invests through but is reported to have backed loans through LendingClub and Climb Credit in the US.
Habal explains the fund’s approach to Peer2Peer Finance News, when they may be ready to invest in UK platforms and his number one rule.
Marc Shoffman: Which regional markets are you focused on?
Hadi Habal: Everything we have done so far has been in the US. The risk-adjusted returns continue to be superior in US dollar terms compared with everywhere else.
The only other market that made sense was the UK but we hit the pause button after the Brexit vote.
There was too much currency risk as we are dollar denominated. We decided not to proceed until there was more clarity and four years later we still haven’t made any investments.
We need to be comfortable with the volatility in the UK first before investing.
Other than the US, the UK is the only other market that provides depth, a common scoring standard for consumer credit, a legal framework and societal respect for contract law.
Both legal systems are rooted in the same legal code.
The UK has a distinct advantage in business lending which is why Funding Circle came out of the UK and not the US. We don’t have a Companies House equivalent.
Small business lending in the US didn’t take off in a comprehensive manner until you had payment system companies provide their own solution, outside of that there is no common data.
MS: Are there not opportunities in Europe?
HH: Europe sounds interesting but when you look at implementation, the attractiveness comes down.
First there are the risk-adjusted returns, which are meagre.
We are in a world where returns are low, but they are depressed even further in Europe as the
region’s governments are stepping in to buy collateral.
There is this conceivable large market that should be attractive on paper but the returns are way below the hurdle rate.
The European Union also has operational challenges and roadblocks, with lots of bureaucracy that you don’t get in the US or UK when setting up a business.
Looking at capital allocation, am I better off investing in a small opportunity in France or something potentially bigger in the US?
Ireland is culturally the most similar, the problem is depth. Would HCG set up an entity to purchase loans that originate in Ireland on a standalone basis? That wouldn’t be the best use of capital.
MS: How do you decide where to invest?
HH: Every time we look at an opportunity we have to assess it in its own micro market which limits choice.
There is a cultural parallel that’s important.
There has to be an acceptance that someone is going to borrow and pay back credit without somebody needing a stick to chase them.
That social contract is really important and is often found in a country’s DNA.
If you look at India, which is a huge market with a robust banking system used to microcredit, you would think this would be a great place to go.
The loss experience has been higher in India though as there is a perception that they can get away with not paying money back.
The Africa experience has been the same. Platforms have taken the model to go to large emerging markets and leapfrog the banking system with noble intentions to take credit to the masses.
But the reality is that these assets have underperformed.
MS: How do you decide what to invest in?
HH: My number one rule is you have to grow slower than the growth in that market.
You are always tempted, when you see something new, to grow as fast as you can.
The problem is you may end up with more capital than the opportunity. In that situation your inclination as an asset manager is to deploy the capital, so you end up doing stupid things and make sub-optimal decisions because you grew too fast.
That’s painful at first but it gives you flexibility, it forces you to be disciplined.
In the early days we invested in consumer loans as there wasn’t anything else.
In the US the next largest market was state-backed student loans. The pricing on these didn’t work for us as it was too long-dated and the riskadjusted return didn’t fit.
The next vertical is small businesses but this is limited because of the lack of centralised scoring systems.
Our view early on was that allocating to small businesses in the US was tricky as there isn’t a dataset to train a platform for credit underwriting.
It is much easier to underwrite consumer loans.
The market we looked at after consumer was fix-and-flip real estate mortgages, which is similar to the work LendInvest does in the UK.
We think LendInvest is an attractive platform.
There is lots of residential data in the US as there are many people buying homes, rehabilitating them and then flipping them for profit.
It also has the security of the property.
It’s a great business to be in coming out of a recession but it is cyclical and we stopped buying those mortgages two years ago.
On a risk-adjusted return basis there are plenty of opportunities elsewhere in other sectors.
We are active in skill-based education and payment systems around small businesses.
MS: What is the biggest challenge for an institutional investor?
HH: The biggest challenge we have is educating investors about the asset class, particularly around losses.
At a basic level we invest in loans. Those loans look like many loans that have been around for hundreds of years
Losses are going to happen.
Some investors come in and say I can buy this consumer credit yielding 13 per cent, they buy a pool of loans and find their net return is five per cent and they cannot reconcile why.
Investors also don’t understand the nuances around prepayment.
In the US and the UK, the majority of loans can be repaid early with no penalty but then there is less interest paid to the investor.
One has to underwrite that loss expectation from the beginning.
My sales team is talking to asset managers and family offices.
Often, they will just say it must be too risky for such high rates of return.
But then you point out how much they are paying on their credit card and they are shocked to see it is a lot more.
These are conversations with professional investors so you can imagine what it is like with retail investors.
Driving forward More P2P platforms should look at car finance, writes Michael Lloyd
CAR FINANCE IS AN
area relatively untapped by peer-to-peer lending platforms, with one exception. Consumer lender Zopa is the only P2P car finance provider in the UK, specifically offering car loans, as well as a personalised car hire purchase (HP) product.
Some platforms – for example, Lending Works and Elfin Market – offer consumer loans which can be used to purchase cars. And RateSetter provides asset-backed finance for dealerships to stock up on cars, funded by its investors.
Following its acquisition by Metro Bank, RateSetter’s unsecured personal loans – which can be used to buy cars – will be funded by the challenger bank rather than its P2P investors.
But Zopa is still the only P2P lending platform offering a specific car finance product.
Buying a car with car finance is pretty similar to purchasing a house, in the sense that there is a valuation and the consumer works with a broker to find the best deal.
But it gets more complicated when it comes to personalising specific products.
A standard car loan is where the provider lends enough money to make up the shortfall between the car’s price and valuation, so that the borrower can buy it outright. The borrower will then repay the lender in monthly instalments over an agreed period, adding preagreed interest.
HP is where the borrower makes monthly payments to a car finance company to hire the car and will only own it after the final payment.
Meanwhile, personal contract purchase (PCP) products have lower monthly repayments because the consumer is only paying a portion of the car’s value. At the end of the contract, the borrower can pay a final balloon payment of what the car is worth to keep it, or they can keep the car by continuing to hire it back as it depreciates in value, or return it and take out a new arrangement on a fresh car.
“Going back 30 years, people owned cars from day one by paying with cash or a personal loan,” said Adrian Dally, head of motor finance at the Finance & Leasing
Association (FLA).
“HP came out after that and was the most popular [option]. It reduced the risk and interest rate, which is very attractive to buyers.
“Then PCP took over and is currently the most popular, having been so for the past 10 years.”
But with only one platform offering a specific car finance product, the P2P sector appears to be missing a trick. alternative financing products via online channels,” he says.
“In fact, our most recent research even highlights that people in the UK are becoming more open to shopping around for their own car finance deals, with 60 per cent saying searching online for car finance is their preferred option.”
Zopa’s research suggests that car finance is a niche that deserves a closer look. And it appears that some P2P platforms are starting to realise the opportunities in the car finance market.
William Rist, head of partnerships at Lending Works, says that the consumer P2P lender will conduct its own research and development (R&D) on the market, before considering whether to launch into this space.
“It is a market that is interesting to us,” he says.
“When we look to go into a new market, we conduct extensive R&D to make an informed decision about if we think it is a market we can do well in or not. This is something we will do in due course for car finance, however there is no date for that
Tim Waterman, chief commercial With lots of P2P business and officer at Zopa, says the platform property lending and still relatively entered the car finance market little personal lending in the P2P after noticing that traditional car space, car finance is one of the few financing options were slow to holes remaining in the industry. adapt to consumer needs. Neil Faulkner, managing director
“With unsecured car loans of P2P analysis firm 4th Way, being one of the key reasons expects this to change due to the customers came to Zopa, we “attractive economics” of this identified a great opportunity lending segment. to provide a better service to “It surprises me that no P2P customers and greater access to lending company in the UK has
piece of work to kick off yet.” taken on the niche of car finance as its main focus and there is certainly a lot more space for car loans,” he says.
“I hope that P2P lenders are giving car finance some serious thought. Borrowers need it and investors could always benefit from even more lending diversification.
“Based on the attractive economics of vehicle financing, I would expect that both P2P consumer lending and P2P business lending platforms would consider tapping into this space.”
There are plenty of reasons as to why platforms, especially those offering personal loans, may want to consider car finance. 4th Way’s pre-Covid data on P2P car finance showed losses before interest of four per cent over the full life of any loans, which are easily covered by less than one year's interest, while average lending rates are seven per cent per year.
“Bearing in mind the ease with which lenders can theoretically spread across a large number of car loans, the risk-reward basis for this
kind of lending makes it a good way to diversify,” Faulkner says.
“Recoveries of car finance bad debt in the P2P lending industry have not been impressive, suggesting that, if more specialist expertise was brought in, losses would come down further.”
Another allure of the car finance market is its significant growth in recent months.
During the March 2020 lockdown, the car finance market all but disappeared, with dealerships closed and consumers purchasing cars via click and collect orders. But since then there has been an uptake in car sales, and thus car finance.
In September 2020, according to FLA figures, the market reported annual growth in new business volumes of seven per cent compared with the same month in 2019.
Meanwhile, the risks of the pandemic have led to more people seeking to buy second-hand cars as a safer alternative to public transport.
“In light of Covid-19, more people are switching from public transport to getting back on the road as a safer way of travelling,” says Callum Walsh, managing director of car finance broker Match Me Car Finance.
“I feel whilst Covid-19 has had a financial impact on the economy and people’s personal circumstances, there will always be a need for car finance and that need can only get stronger as a result.”
Platforms can enter this space relatively easily by undercutting the current deals while still offering competitive car loans to borrowers, and charging enough interest and fees to cover risks.
However, the market is not very competitive on fees, and new rules from the Financial Conduct
Authority will be implemented in January 2021 to ban discretionary commission models that some car retailers and motor finance brokers use.
Zac Choudhri, who launched car finance broker Prime Personal Finance in January this year, says his firm charges less than the main dealers, at about seven to nine per cent.
“The lowest the main dealers go to is about 9.9 per cent, while that’s the highest we charge,” he says. “It hasn’t been very competitive for us offering lower rates.”
Affordability and creditworthiness are key factors that lenders look at when assessing borrowers, and the pandemic has led to lending being tightened across the board.
Choudhri says it’s much more difficult for anyone with a thin credit file or people who are self-employed to obtain PCP car finance now.
“If you're a prime customer with a great credit score and history it’s very easy to get car finance and you can be approved on the day, maybe even within 15, 20 minutes,” he says.
“But for those with a thin credit file or who are self-employed, it
depends how the provider responds.
“Even if they are working throughout the lockdown and the current climate, providers think these borrowers may not be able to sustain payments in the future.”
With car finance providers tightening their belts, now could be a great time for P2P platforms to enter this space. If they partner with an open banking provider, it could be even easier.
Credit reference agency Credit Kudos is working with several lenders and brokers in the car finance market to provide up-todate open banking insights to help them better measure a borrower’s creditworthiness.
This helps customers access more financing options faster, especially supporting those traditionally underserved such as the self-employed.
Waterman says Zopa helps borrowers access car finance by offering secured and unsecured car finance loans as separate products, with both options funded by its P2P investors and its bank.
“For our HP offering, we carry out
all background checks on the car, process all online paperwork and contact dealerships directly about the money,” he explains.
“Offering both unsecured personal loans and HP makes it easy for people to pick the finance option that works best for them.”
Nick Harding, chief executive of Lending Works, believes that personal loans for car purchases do have their place.
“PCP requires a vehicle worth a certain amount in certain conditions,” he comments.
“Borrowers might use a personal loan to make up the balance to buy an older car they can’t get a lease for.
“But if a borrower is unable to get car finance, they are unlikely to get a personal loan to purchase the car. Car finance typically has more flexible credit risk appetite, with the security in the vehicles, whereas unsecured loans have tighter credit.”
While Harding is interested in the opportunities presented by car finance, other P2P consumer lenders such as Elfin Market have told Peer2Peer Finance News that they are not considering making any inroads into the space.
With more people getting back on the road in the pandemic era, car finance is set to continue to grow, so this is an untapped opportunity for the P2P sector. As the market grows, perhaps more platforms will follow Zopa’s lead and realise the car finance space is worth a closer look.
INVESTMENT PLATFORMS
The House Crowd has raised over £120m from retail investors and paid out over £50m in capital and interest. Investors can earn up to seven per cent per annum through its auto-invest product and invest tax-free via its Innovative Finance ISA or SIPP. All loans are secured against UK property.
www.thehousecrowd.com T: 0161 667 4264 E: member-support@thehousecrowd.com
LandlordInvest matches professional landlords looking for financing with investors that are looking to invest in asset-backed products with a monthly income. Loans range between £30,000 and £750,000. Investors can earn between 5-12 per cent per year, with the option of an Innovative Finance ISA wrapper.
www.landlordinvest.com T: 0207 406 1491 E: info@landlordinvest.com
Sancus is an alternative finance provider specialising in bridging and development finance across the UK, Ireland, Jersey, Guernsey, Gibraltar and the Isle of Man. Borrowers benefit from expertise, flexibility and greater speed than traditional suppliers of funding. Co-funders participate in a range of asset backed, risk-adjusted returns through its interactive digital platform.
www.sancus.com T: 0207 022 6528 E: Richard.whitehouse@sancus.com
Wellesley is an established property investment platform that issues bond investments to the UK retail market. Its core objective is to provide investors with higher rates of return than can be accessed through traditional investment routes, whilst simultaneously providing financing to experienced commercial borrowers within the UK residential property market.
www.wellesley.co.uk T: 0800 888 6001 E: info@wellesley.co.uk
SERVICE PROVIDERS
Duff & Phelps is the world’s premier provider of governance, risk and transparency solutions. The firm assists P2P clients at every stage of the business lifecycle, in the areas of valuation, corporate finance, restructuring, debt advisory, disputes and investigations, cyber security, claims administration and regulatory compliance.
www.duffandphelps.co.uk T: +44 (0)20 7089 0834 E: mark.turner@duffandphelps.com
SERVICE PROVIDERS
Grant Thornton’s restructuring team provides practical advice to mitigate the impact of both internal and external stresses on its clients and their stakeholders. The team is able to assist its P2P clients with regulatory, financial and operational challenges as well as providing restructuring or wind-down support.
www.grantthornton.co.uk T: 020 7865 2302 E: Chris.M.Laverty@uk.gt.com
Quantuma is an independent advisory firm serving the broad needs of midmarket and corporate companies and their stakeholders. It has deep experience in the peer-to-peer lending sector, principally in relation to mitigating risks associated with borrower distress and related areas of regulatory compliance. Quantuma works alongside a wide range of platforms.
www.quantuma.com T: 07770 210628 E: frank.wessely@quantuma.com
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