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This article first appeared in Personal Wealth, The Edge Malaysia Weekly on December 16, 2019 - December 22, 2019

The local peer-to-peer (P2P) financing industry has seen healthy growth under the watch of the Securities Commission Malaysia (SC) in the 2½ years since the first platform was launched.

According to the SC’s official website, a total of RM521.7 million had been raised by six licensed P2P financing platforms to fund the businesses of 1,560 small and medium enterprises (SMEs) in the first nine months of the year alone, up 150% from the whole of last year.

The number of registered investors had risen steadily, especially on the more active platforms — Funding Societies Malaysia, Fundaztic and B2B Finpal. According to their spokespeople, there are 35,000, 17,000 and 1,500 registered investors on those platforms respectively while the number of active investors are lower at about 10,000, 5,000 and 900.

New products have been rolled out in the past 2½ years, providing investors with more options. These include dealer financing products, launched by Funding Societies in August to finance used-car dealers so they can easily purchase pre-owned vehicles.

Funding Societies and Fundaztic have partnered online retailer Lazada to finance the businesses of the latter’s e-commerce merchants, some of whom require working capital to grow their revenue or bridge any short-term liquidity gap. The P2P financing platforms conduct risk assessments on these merchants by utilising alternative data provided by Lazada with the consent of the merchants.

Four new platforms — Money Save Capital PLT, Bay Smart Capital Ventures Sdn Bhd, Crowd Sense Sdn Bhd and microLEAP PLT — are expected to be launched in the near future. This is expected to make the P2P financing industry more vibrant.

Money Save Capital and Bay Smart Capital Ventures aim to carve out a niche in the area of supply chain financing while Crowd Sense and microLEAP are eyeing the insurance premium financing and micro-finance space respectively.

Supply chain financing facilitates the payment of a seller’s invoice via third parties while insurance premium financing will see third-party platforms raise funds from investors to finance SMEs’ purchase of insurance policies such as those for fire or theft.

In terms of the average return on investment, Funding Societies, Fundaztic and B2B Finpal say they have managed to generate mid-single-digit to double-digit returns for the investors on their platforms. As at Nov 20, investors on Funding Societies had seen an annualised net return (before tax) of “mid to high single digit”, according to Wong Kah Meng, CEO of Modalku Ventures Sdn Bhd, which operates the platform.

Fundaztic provided its investors with returns of 11% to 15% while B2B Finpal generated 10.38%, according to Kristine Ng, CEO of Peoplender Sdn Bhd (which runs the Fundaztic platform), and Chua Chin Hang, chief technology officer at B2B Finpal Sdn Bhd.


Rising defaults and investor expectations

However, as the industry matures and macroeconomic conditions weaken, the platform operators have begun to face some challenges, particularly with the rising number of default cases and managing investor expectations.

When many of the licensed P2P platforms started operations in 2017, the industry did not see any defaults. However, default cases began to emerge across the platforms last year. Some investors who received lower-than-

expected returns as the result of the defaults have expressed concerns about the accuracy of the average default rate published on the platforms’ websites and mobile apps.

To address these concerns, the three platform operators say they continue to generate healthy returns for their investors while keeping the default rate under control. As at Nov 11, Funding Societies had an annualised default rate of about 2%, Fundaztic’s ranged from 5% to 8% and B2B Finpal’s was about 1.34%.

While industry statistics in developed markets are not easily available, the default rates of two prominent platforms — LendingClub and Zooppa — provide some context for comparison.

US-based P2P lending company LendingClub does not publish its default rate on its official website. However, its charge off amount (which means uncollected debt) against total disbursement of funds ranged from 5.39% to 11.31% from 2014 to 2018. Its adjusted annualised return stood at 4.28% to 6.76% during the period.

UK-based P2P lending company Zooppa, which was founded in 2004, had a default rate of 0% to 4% from 2005 to 2013 and 1% to 4.3% (these figures could change as several loans have yet to mature) from 2014 to 2018. The platform had a rate of return of 4% to 6% from 2011 to 2018.

It is worth noting that the P2P financing platforms in Malaysia issue investment notes to businesses only and not individual borrowers, like LendingClub and Zooppa. Also, they have a different definition of defaults.

The industry players point out that every investment comes with risks and that defaults are bound to happen in P2P financing as it provides funding to SMEs that could not borrow from banks due to a lack of business track record or collateral. The platform operators have been educating investors on the probability of defaults in the industry over the past 2½ years.

Investors can make a rough comparison between the default rate of P2P financing and that of banks’ SME financing. The non-performing loan rate of the latter tends to fall between the mid and high single digits, says Wong.

That is why diversification is an important strategy for investors to mitigate losses. Funding Societies and B2B Finpal introduced auto-invest features so that investors can determine the exposure they want have to each investment note and issuer.

Fundaztic emphasises on diversification through its Principal Protect feature. Those who invest in more than 100 notes on the platform within 12 months, among other criteria, will have their investment (of between RM10,000 and RM30,000) protected.

In response to investors who are sceptical about the default rate posted on Funding Societies’ official website, Wong says these investors are likely to have invested a larger sum of money in investment notes that defaulted. “Instead of using auto-invest, they may have manually placed a larger bet on some individual notes that defaulted later on. There are also investors who invest through the platform’s auto-invest feature, but sometimes log in to the platform to invest larger sums in individual notes manually.”

As a result, the rate of return and default rate of those investors’ individual portfolios have deviated further from the platform’s average default figures. Investors would have reduced the likelihood of being impacted by a default if they had utilised the auto-invest feature since their investments would be spread across more notes, he adds.

Wong says the platform has been trying to manage investor expectations but it has not been easy, partly because P2P financing notes did not see any defaults in the first year. “It is only natural that they become upset when defaults start to emerge in the second year.”

Ng points out that there is a difference between understanding that a default could occur and experiencing one. “A lot of investors know defaults will happen. But when it does, even if the default rate is just 1%, they start jumping. This is the awareness that we need to create among our investors,” she says.


Other challenges

Wong says Funding Societies needs to strike a balance between business expansion and generating reasonable returns for investors. He adds that its team has doubled to about 100 employees this year, which has enabled it to reach out to more investors and SMEs.

The platform has partnered e-commerce platform Lazada to finance online merchants as well as myTukar, MUV Marketplace, CarlistBid and Carsome to finance online merchants and used-car dealers. The upside is that the investors on the P2P financing platform have the opportunity to increase their investments. However, doing so could also cause the default rate to rise as the investors would be financing SMEs with lower credit scores and have a higher probability of default.

Investors should understand that the mandate of P2P financing platforms is to raise money from the public to fund underserved SMEs, says Wong. Platforms such as Funding Societies can create a significant impact on the economy when they serve more SMEs rather than just a select few with high credit scores.

“Initially, the situation was more of financing a couple of deals with zero default rate. Now [when we expand the offerings], investors who used to earn double-digit returns will be earning mid to high-single-digit returns. This is the interesting dynamic we need to manage,” he says.

One more challenge that the industry faces is a lack of a centralised system for platform operators to check whether an SME has taken several loans from multiple platforms, says Ng. She observes that a growing number of businesses are doing so and it is difficult for platforms to identify them.

“Some of them may take a loan from one platform for working capital purposes and then take another loan from another platform for, say, refurbishment. They take on multiple loans [which could cause them to overleverage and default on their payments],” she says.

She adds that it would be helpful to have a centralised system and P2P operators could actively feed information into the system.

Currently, the platform operators are trying to address this issue by looking closely at the SMEs’ bank statements, says Wong. “We can detect it when conducting our due diligence process. For instance, we look at their bank statements and we may see payments made to other P2P financing platforms. We may also detect such situations by looking at their audited financial reports. However, it is less efficient.”


Future developments

Going forward, there will be more opportunities to participate in P2P financing as some platform operators continue to grow their businesses. Funding Societies and Fundaztic have already embarked on their expansion plans locally.

B2B Finpal, which currently serves a limited group of SMEs (mainly suppliers in the retail sector that use the services of its parent company, B2B Commerce Sdn Bhd), is looking to expand into the e-commerce sector. “We want to expand our lending portfolio to support the online merchants,” says Chua.

Singapore-based Funding Societies has already established a presence in Singapore, Indonesia and Malaysia. Fundaztic and B2B Finpal are looking to expand in the region.

Ng says Fundaztic has received the approval of the Monetary Authority of Singapore to launch its platform there and is talking to the authorities in Thailand to do the same. Chua says B2B Finpal is looking at Thailand and Indonesia.

Like Fundaztic, B2B Finpal will soon see the launch of its Principal Protection scheme that protects investors’ investment principal in exchange for a lower rate of return. Meanwhile, Funding Societies is in talks with the SC to launch its shariah-compliant products. “It is still work in progress and I can only share more if we receive regulatory approval,” says Wong.

Fundaztic is looking to introduce a secondary market on its platform so that investors can trade their notes. This will increase liquidity on the platform.

Ng says most of the investment notes listed on the platform have tenures of 24 to 36 months, which some investors consider too long. “We are prepared and are able to roll out the secondary market quickly when the regulator announces the [secondary market] guidelines. The SC has verbally indicated that the guidelines will be out by the end of the year.”



Simple versus effective interest rates

P2P financing platforms use different ways to calculate the rates of return that are published on their websites. For instance, Funding Societies Malaysia and B2B Finpal calculate returns using the simple interest rate while Fundaztic uses the effective interest rate.

Calculating returns using the simple interest rate is meant to be intuitive. It is always expressed as a fixed percentage and does not take into account the compounding period. For instance, a person lends a friend RM10,000 at a simple interest rate of 10% per annum for a period of 12 months. At the end of the tenure, the lender gets a return of RM1,000.

Calculating returns using the effective interest rate is a less simple approach. To put it plainly, an effective interest rate includes the compound interest earned during a payment plan. As a result, the effective interest rate tends to be 1.8 times higher than the simple interest rate in the case of a 12-month term financing note due to the different payment structure, says Wong Kah Meng, CEO of Modalku Ventures Sdn Bhd, which operates Funding Societies.

For instance, a person lends a friend RM10,000 at an interest rate of 10% per annum for a period of 12 months. However, the friend has to pay one-twelfth of his principal and one-twelfth in interest each month. At the end of 12 months, the lender gets a return of RM1,000, but the effective interest rate of the loan is 17.97%.

This happens because the lender is receiving a portion of his principal plus interest each month. But he continues to earn interest on the funds he lent to his friend, which was RM10,000. This means that the borrower is not paying his loan based on the reducing balance method.

Kristine Ng, CEO of Peoplender Sdn Bhd, which operates Fundaztic, says investors should look at the effective interest rate when investing in longer-term P2P financing notes such as those with tenures of 24 to 36 months. “Investors should understand that if they calculate their returns in the simple interest rate, it means they will get back their principal [in one lump sum] at the end of the tenure.”

She adds that the money investors are paid each month could be used for other purposes such as paying utility bills or invested in other financial instruments or products.

The calculation of the simple and effective interest rates will not yield a very different result in the case of shorter-term investment notes such as those with a three-month tenure. The calculation of the effective interest rate also does not apply to invoice financing notes, where investors only get back their principal in full at the end of the tenure.

Funding Societies’ Wong does not provide Personal Wealth with the platform’s rate of return calculated in the effective interest rate. He points out that the platform provides term financing and invoice financing products, among others. “It is easier for us to provide it in the simple interest rate.”

B2B Finpal quotes its average return in the simple interest rate as it provides invoice financing notes and the principal is only paid when the notes mature.



SC to standardise calculation of default rates

Wong Kah Meng, CEO of Modalku Ventures Sdn Bhd, which operates Funding Societies Malaysia, says the Securities Commission Malaysia (SC) is planning to standardise the calculation of the default rates published on the P2P platform operators’ websites.

“Each platform publishes a default rate that has been calculated using a slightly different method. The standardisation means everyone has to follow a set formula,” he adds.

Funding Societies defines the default rate as the total defaulted amount divided by the total disbursement amount since the first day it started operations, says Wong. The default rate of 1.49% (as at Nov 20) published on its website is the regional rate and not the default rate in Malaysia, he adds.

Kristine Ng, CEO of Peoplender Sdn Bhd, which operates Fundaztic, says the default rate published on its official website is calculated by the amount funded divided by the amount in default. Both figures are available on the website.

She adds that the default rate is adjusted every six months to derive the annualised rate. The adjustment is made by subtracting the written-off payments, which are investment notes continuously not paid for more than 180 days, from the total defaulted amount.

“The display of the rate is on our landing page, which means even if you are not a member or investor of our platform, you can see it. Your experience of investing in P2P financing may be zero. Imagine, if we do not take out those that have been written off and annualised the rate, you may think it looks very bad,” says Ng.

“For instance, my default rate is 1% per year and 10% over 10 years. When an investor looks at 10%, he may not be able to accept it and may not understand that the rate should be divided by 10.”

However, the default rate shown in the individual portfolios of investors does include the write-offs.

Wong and Ng welcome the SC’s decision to standardise how the default rate is calculated across the platforms as it would provide more clarity to investors and increase the level of transparency in the industry.

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