This article first appeared in Wealth, The Edge Malaysia Weekly on November 30, 2020 - December 6, 2020

The Malaysian peer-to-peer (P2P) financing universe has grown significantly over the last few years, and there is now a diverse range of products for investors to choose from.

Much will depend on the investor’s risk appetite and investment time horizon.

Industry players who spoke to Wealth suggest that, as a rule of thumb, P2P financing as an asset class tends to fall between fixed income and equities in terms of risk-return.

The asset class has a higher risk-return compared with fixed income because of the type of business being financed: small and medium enterprises (SMEs). SMEs tend to be riskier financing propositions in general. Concurrently, the asset class is less risky than equities because investors do not have to worry about capital depreciation (share price movements). But, P2P returns are not expected to match that of equities.

Also, unlike equities, a P2P investor is considered a creditor, and therefore potentially able to recoup at least some portion of capital in the event the issuer goes bankrupt. This, however, does not apply across the board, with at least one platform choosing to eschew collateralisation altogether.

Another thing that industry players broadly agree upon is that within the P2P universe, it is now possible — to an extent — to rank individual P2P products in terms of risk and return.

A key caveat applies, however. While it is possible for products within individual P2P platforms to be ranked, the same cannot be said for ranking products across P2P platforms. This is because platforms have their own unique metrics and proprietary methods for creating products, as well as calculating returns and default rates.

Hence, barring some harmonisation of certain processes, it will not be possible to build an industry-wide ranking system, such as those that already exist within the unit trust industry, for example, with The Edge-Lipper Fund Tables.

As a starting point, P2P products with some form of collateral attached are generally perceived to be less risky than products with no collateral, or unsecured products.

These products may appear on an investor’s feed, clearly denoting its lack of collateral or its being an unsecured product. Alternatively, the product would appear bearing the business owner’s “personal guarantee”. This too, denotes that that particular product is unsecured, or lacking collateral. The way this information is presented to the investor may differ from platform to platform.

Loan tenure is another marker for risk. Generally speaking, P2P products with shorter repayment tenures tend to be less risky.

It is worth noting that in order to further minimise overall risk (as well as provide more options for P2P investors), P2P platforms in Malaysia tend to have unique arrangements with various third parties.

These third parties — which generally provide some form of industry-specific aggregator service (such as used-car trading portals) — tend to add at least one additional layer of quality control over prospective issuers, up and over the P2P platforms’ internal prerequisites. This can be observed across most active P2P platforms in Malaysia, regardless of whether they provide collateralised products.

A good starting point, therefore, would be for investors to consider the various products available within a particular P2P platform, and then attempt to make an informed decision as to the relative performances of each platform.

We look at the main platforms below.

This is arguably the most prominent player in the market and currently enjoys a big chunk of the P2P market share in the country, says its CEO Wong Kah Meng.

The company offers four products. In order of ascending risk, they are dealer financing, accounts receivable financing (formerly known as invoice financing), accounts payable financing and business term financing.

Wong says the first two are generally less risky, given that they come with collateral. “In the event the SME issuer defaults on the financing, there is a possibility for recovery,” he says. Dealer financing is taken up by local used-car dealers to finance the purchase of inventory, which they then sell on the open market.

Accounts receivable financing is where the issuer sells its future receivables or invoices to get immediate cash. Once the issuer’s client pays the invoice, P2P investors who initially financed the accounts receivable note would receive full payment and make a percentage return on their initial investment.

There are other higher risk, higher return products on offer. At this point, the products do not tend to come with security. This means investors are categorised as unsecured creditors and would be much less likely to recoup their capital in the event an issuer goes under. On the other hand, the interest repayment tends to be a lot higher, reflecting the increased risk that the P2P investor is taking on.

“Unsecured products such as accounts payable financing and business term financing tend to be used for more generalised purposes and may come with longer tenures,” Wong says.

Accounts payable financing is an unsecured product used to finance, for example, an issuer’s purchase of raw materials needed for the manufacture of steel pipes. The tenure ranges from 15 to 150 days, with bullet repayments of the full principal and interest due at the end of the tenure.

Business term financing, meanwhile, is a financing product that allows issuers to break up repayment into monthly instalments of up to 18 months. “This sort of financing is typically used by issuers as general working capital,” Wong explains. At present, most of the notes that appear on Funding Societies are either dealer financing or term financing notes.

Looking at returns across the platform, and taking into account fees and defaults, Wong says they typically fall in the mid-single-digit range. “It really depends on the diversity of your portfolio. For example, if an investor favours dealer financing, the returns would be roughly 8% net of fees and defaults.

“Meanwhile, looking at business term financing and accounts payable financing, annual returns before fees, taxes and defaults would range from 10% to 14%.”

This P2P platform, also known as CapBay, is making a name for itself as a specialist in invoice financing, which its CEO Ang Xing Xian says makes up roughly 90% of the company’s business.

Issuers on CapBay, he adds, tend to be government contractors, which makes them exceptionally low risk to finance, since the government is the paymaster in these instances.

Having said that, CapBay also offers other forms of P2P financing, albeit on a limited basis, and generally only to issuers with outstanding track records. Ang says CapBay’s products, in order of ascending risk, are notified factoring (a form of invoice financing), collateralised financing (dealer financing), non-notified factoring (a riskier form of invoice financing), unsecured working capital financing and, finally, general revolving credit.

While most of the products here are reasonably well defined, investors tend to be unaware of the key differences between notified factoring and non-notified factoring.

“Not all forms of invoice financing are created equal,” Ang says. The key difference lies in who CapBay collects repayment from. “In the event we don’t receive payment directly from the issuer, we could go directly to the paymaster and ask for invoice payment; this is what we refer to as notified factoring.”

Notified factoring allows CapBay to bypass the issuer and collect payment directly from the paymaster. The default rate for this form of invoice financing is less than 1%, Ang says.

In the case of non-notified factoring, the process would begin in just the same way, with the issuer selling its invoice on to the lender — in this case, CapBay’s various P2P investors. However, the issuer still collects payment directly from the paymaster and only then pays what is owed to the lender.

“With non-notified factoring, lenders do not have real ownership of the invoice, despite having purchased it from the issuer. Without this so-called ‘legal assignment’, we would not be considered the highest priority creditor for payment of the goods in question.

“Under notified factoring, however, the invoice and all the rights that are attached to it vest in us as the lender. Other creditors cannot touch the money, as we have jumped to the front of the queue.

“It’s important that investors understand how these two forms of invoice financing differ, because while the difference is subtle, the implications for repayment and defaults can be significant.”

Broken down even further, CapBay’s overall invoice financing business mainly comprises the less risky notified factoring, which is roughly double that of its non-notified factoring business. “Returns for both products tend to fall in the 5% to 7% range per annum, but there is considerably less risk in notified factoring,” Ang says.

Peoplelender Sdn Bhd, the operator of P2P platform Fundaztic, has taken a different tack from its peers. Its acting CEO Calvin Foo says the company operates in the decidedly higher-risk unsecured term financing space.

“We refer to this as clean term financing, with ‘clean’ denoting that the product is unsecured. About 90% of our loans are clean term financing, with an average repayment tenure of 30 months. Investors can expect between 7% and 11% returns per annum after fees,” he says. Fundaztic’s default rate currently stands at 3.4% per annum.

The remaining 10% of loans comprise various partnership-derived P2P products, whether clean term financing or, alternatively, dealer financing. Fundaztic’s dealer financing notes are also unsecured, which is by design, says Foo.

“Investors often believe that having collateral means their investment is more secure. It’s not always that simple. Take the example of a used-car dealer who has received a loan from us to finance the purchase of 10 cars but is now in default and unable to repay the loan.

“As the lender, I can repossess the 10 vehicles but this involves effort and costs. Then, we have to think about storage costs for the inventory and, eventually, we will need to sell the cars off. There is no guarantee that we can even sell these cars. Meanwhile, the vehicles continue to depreciate in value.

“The loan is crowdsourced from our P2P investors. Ultimately, the costs associated with liquidating the collateral will have to be passed on to the investors,” Foo explains.

Instead, Fundaztic relies on what Foo says is a unique strategic advantage over the broader P2P ecosystem. Fundaztic, he says, is the only P2P platform in the market that has successfully automated the entirety of the P2P application and evaluation process.

The company’s “credit engine” — a term Foo uses to denote its proprietary and fully automated application and evaluation process — was developed by one of the company’s founding directors, Gary Tan. He is a veteran of the banking industry and a pioneer of programme lending in Malaysia.

Programme lending refers to a harmonised set of rules for credit approval for borrowers with broadly similar characteristics or product needs. “Programme lending is essentially an automated lending process whereby approvals are made based on applications satisfying certain algorithmic prerequisites.

“It’s a fairly common tool in the banking industry but, to the best of my knowledge, we are the only player in the P2P ecosystem with such a tool. Further, the entire process — from application and evaluation to approval — takes roughly 10 minutes,” says Foo.

As an additional risk mitigation strategy, he advises people to approach P2P investments with a “portfolio mindset”. The key, he says, is to build a portfolio of hundreds of issuers, by investing small amounts in each. “Investors should look at P2P investments in the way that banks view the credit card business. Banks have such large credit card businesses because their strength is in the volume. Having a large enough volume will ensure that investors are protected against defaults.

“Since Fundaztic operates on a monthly repayment model, as opposed to a bullet repayment model that other platforms may run on, investors can expect to receive monthly interest repayments. You can therefore more effectively take advantage of the compounding nature of investments and reinvest returns in yet more P2P notes.”

Platform operator CoFundr is the latest entrant into the growing P2P ecosystem in Malaysia. Headed up by CEO Paul Kuan, a veteran of the banking industry, CoFundr provides a new and more niche P2P product — business insurance premium financing (IPF). CoFundr also provides working capital financing (WCF) notes to P2P investors, although this is a more widely available product.

CoFundr’s IPF note allows investors to crowdsource insurance coverage for SMEs and provides financing of up to 75% of the total premiums payable to the insurer.

With this financing, SMEs are able to fund their business insurance premiums without risking interruption to their policy coverage. Instead of making the full upfront payment, which can be a significant burden on cash flow, SMEs pay a small portion, with the rest financed by CoFundr’s P2P investors. SMEs would then get on a scheduled monthly repayment plan, which allows them to repay the investors with interest.

“In the event of a default, we will be able to request cancellation of the insurance policies that we have financed, and secure a refund of the unearned premiums remaining on the policies in order to cover the outstanding principal on the note,” Kuan explains.

While the credit risk on the insurance premium financing note may have been based on the company’s assessment of the issuer’s creditworthiness and repayment ability, this is offset by the fact that recovery would be conducted against the highly rated, well-capitalised insurance companies that originally issued the policies.

This, according to Kuan, allows CoFundr to offer higher returns at relatively lower risk. Projected average annual returns for IPF notes are 7.2% per annum, with tenures of eight months or less, he says. Meanwhile, the projected average annual return of WCF notes is around 9.6% per annum, with tenures of 24 months or less.

Although Kuan has declined to offer a risk-return rank order for CoFundr’s IPF products, he says the company’s WCF notes would be similar to generalised WCF notes offered by other players in the market.

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