Update on HNW Lending’s Pause In Lending

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Update on 28th October, 2020

HNW Lending has given us more good news today. It says the financial regulator has now allowed it to remove the temporary restrictions that HNW Lending voluntarily placed on itself. Ordinary lenders, wealthy lenders and also sophisticated lenders can now lend again. As of this afternoont, the FCA has not yet updated its register to reflect this change.

Improved information for lenders

4thWay has seen examples sent to individual lenders that clarify and add to previous information; for example, about the risks. This is part of the changes that HNW Lending have made to satisfy the regulator.

Change to legal structure

HNW Lending is also now putting some loans through a new, separate corporate entity, called HNW LoanCo Ltd. Using this company, it can offer the same loans that it has already been doing, but they will be unregulated. In doing so, HNW Lending saves itself the huge time and cost of responding to FCA scrutiny. It reduces the revenue-based fee to the regulator in the process. It also removes those loans from the purvue of the Financial Ombudsman, which costs £650 per customer complaint regardless of whether HNW Lending or the customer wins the complaint.

HNW Lending's loans have traditionally only been regulated, because it sets the lending contracts up as straightforward P2P contracts. Outside of the P2P industry, the kinds of loans it does are not normally regulated. So you can expect that HNW Lending has to do a lot of costly work to demonstrate to the regulator how its loans work and to show that most of them are expected to turn out fine after repayments and bad-debt recoveries are completed. Reducing the number of regulated loans is bound to make it easier for HNW Lending to help the FCA review its loan book in future, and likely with much lower costs for external expertise on HNW Lending's part.

What this means to lenders

The main difference from lenders' point of view is that loans put through HNW LoanCo Ltd will not be available in HNW Lending's IFISA.

Loans put through HNW LoanCo are still kept separate from HNW Lending's operating businesses. They are put through a new, separate trust company set up for individual lenders. The legal structure of your lending is slightly different for these loans, but in line with some other P2P lending companies listed on 4thWay. (There are about half a dozen different structures of lending that lead to comparably direct lending between borrower and lender.)

HNW Lending also chooses to continue to use its segregated client account for all loan monies. Your money is paid into this account, transferred to solicitors and on to the borrower. And borrower payments come straight back to this account – not to HNW Lending's own corporate bank account.

I've read through HNW Lending's updated terms and conditions in full. I can see nothing else that's worth noting at this stage.

We'll be checking in with HNW Lending several times over the next year to see how this impacts those with IFISAs. The main factor is ensuring that enough loans are available to spread the risk, but HNW Lending currently expects lenders will continue to have the same level of diversification.

It will be interesting to see if there's any small difference in the risk and reward in future between the IFISA and non-IFISA accounts, although I don't currently see any reason why this would be the case.

And finally…

After a drought in loans caused partly by the pandemic and partly by the pause requested by the regulator, HNW Lending now has quite a few loans coming up.

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Update on 15th October, 2020

The initial article from August is below, but here's an update as of 15th October, 2020.

HNW Lending has informed 4thWay that, roughly two weeks ago, the FCA said it's “a matter of weeks not months now” before coming to its new conclusions on HNW Lending. HNW Lending believes it will then be able to re-open.

The P2P lending company voluntarily stopped new lending in July, after discussions with the FCA, in order to make improvements to its processes. (Details below.)

The FCA has also removed one of the restrictions, so that lenders who are using auto-lend continue to be allowed to re-lend the interest they earn on a quarterly basis. Lenders were therefore able to lend again on the 30th September, 2020, as planned.

Initial update in 30th August, 2020

The FCA has stated that it's asking HNW Lending to go over and improve some of its policies and procedures. In the meantime, HNW Lending has voluntarily agreed with the Financial Conduct Authority to stop any further lending made by small investors, called “retail investors”, at least temporarily. This includes lenders classed as either sophisticated in P2P lending or as high net worth individuals, who will not continue lending new money and buying loan parts from existing lenders.

4thWay's current view is for lenders using HNW Lending to hold and do nothing (not withstanding our standard guidance to spread your money across lots of P2P lending accounts/IFISAs and loans). We'll update you again at the end of September.

It's highly notable that this is not a compulsory suspension ordered by the FCA. Also the FCA hasn't publicised this in an announcement for the press to pick up on, which is standard procedure when a company commits grievous errors and faces serious action. And the FCA is asking HNW Lending to make some changes – it's not shutting it down.

My overall opinion is that the FCA is being cautious about a type of lending that it's unfamiliar with, because it's not usually regulated.

Correction: the first paragraph was corrected to state that sophisticated and high net worth lenders are also stopped from lending at present. Previously it said they could continue to lend.

We talked to HNW Lending and the FCA, and looked into as many details as we've been able to obtain. Let's take a look at those together.

HNW Lending's public statement

Firstly, here's what HNW Lending is publicly allowed to say, with the wording of this statement agreed by the regulator:

“Further to feedback from the FCA and concerns we have in relation to Covid-19 and its impact on the lending market as well as a lack of appropriate lending opportunities, we have temporarily suspended sales of loan participations to retail investors.

“We will write to you once this suspension has been lifted and we apologise for the inconvenience that this may cause you.”

That's not in the least helpful in understanding what the FCA's “feedback” is, so let's move on.

HNW Lending off the record

I talked to HNW Lending's CEO, who was unable to give me any information I'm allowed to publish, since it has to agree with the FCA what it writes in public. (More on that in a few minutes.)

What he told me does seem to correlate with the FCA's version.

HNW Lending on the record

After discussing the FCA, CEO Ben Shaw added that just a very small proportion of loans have lost money or are expected to. He still believes all outstanding bad debts will be recovered in full.

Just one loan has been approved since the pandemic started, but Shaw said that September looks more promising.

Shaw lends in HNW Lending loans taking a first-loss position, which helps to align his interests with lenders.

What the FCA says

The FCA confirmed to 4thWay that it does indeed sometimes ask financial companies to agree any wording that it wants to make public or provide to its customers, which tallies with what HNW Lending said.

The FCA has revealed that it's asking HNW Lending to voluntarily work on its processes in a few areas. It won't provide specific details, but broadly they are in the following categories.

HNW Lending is being asked to review its risk assessment. This might mean creating risk-management policies, implementing them or maintaining them, or a combination of those. It might mean identifying risks from HNW Lending's activities, its processes and systems. It might also mean looking into the risk level that HNW Lending itself can tolerate.

HNW Lending is being asked to review and implement a risk-management framework that fits FCA requirements. This could mean that it wants HNW Lending to change arrangements, processes or mechanisms to manage all the risks of its own business.

Finally, HNW Lending is also to look at risk control of the actual loans, meaning its assessment of its borrowers. This may or may not include how it assesses existing borrowers that are seeking to renew their loans.

Why HNW Lending?

As the FCA doesn't provide details and HNW Lending cannot, we can just speculate as to why it's been asked to do this. Yet there seems to be a few fairly easy hypotheses that we can make. And I believe it will be a combination of these reasons:

1. Swinging

We've always called HNW Lending a “swinger”, which is the 4thWay team's colloquial term for a P2P lending platform that's prepared to sometimes loosely assess borrowers, and even security, provided the overall picture shows that the security considerably outweighs the size of the loan. This is often supported by other appealing factors about the security.

It's partly down to this kind of risk assessment style that these loans can attract higher lending interest rates. Borrowers are pleased because they can potentially get their money faster, which is often a big selling point for these kinds of loans.

Swingers also tend to be peer-to-peer lending or IFISA providers where high proportions of loans turn bad. But – if they are good at what they do – they typically recover these bad debts in full.

As a swinging lender, its no surprise if the FCA is demanding more traditional methodology that it's more familiar and comfortable with. And I don't think that is a bad thing. That would explain what the FCA is asking HNW Lending to look into:

2. Regulator  is unfamiliar with this kind of lending

This sort of lending has not been regulated by the FCA in the past and it's only being regulated at all because its through an online P2P platform. The FCA itself has a learning curve, in my view, to assess the risks correctly. Therefore, I think it's bound to be cautious.

3. Superficial similarities to some closed P2P lending sites

Well-known competitors of HNW Lending – Lendy and FundingSecure – did the same kind of lending, and they turned out badly. The main difference was that those companies appear to have been poor at recovering bad debt. HNW Lending has so far done very well since 2014. Its high proportion of loans at under 50% of the security valuations – often well under – certainly helps.

These kinds of loans have been around for a long time – long before the P2P lending industry existed. So the destiny of the loans comes down to the competence of the people making the decisions.

4. Square pegs in round holes?

If you look at examples of the sort of thing the FCA expects of P2P platforms, it expects loans to be categorised by risk, including an assessment of the chance of a loan turning bad. It also wants to see projections of losses in the event that a loan does turn bad.

This is something that a lender doing HNW Lending's sorts of loans wouldn't normally do – at least not with any kind of mathematical model. The main reason is usually because with these loans you just approve them if you think they aren't going to lose any money even if they turn bad. You just take bad loans on the chin, since the majority of them should ultimately be paid back with interest earned up until repayment.

Another reason these kinds of forecasts aren't done in this lending is that it's not easy to come by a large historical dataset in order to make such precise forecasts. So that could be some thing like a square peg for a round hole, in HNW Lending's case.

Similarly, a P2P lending company also needs to regularly assess whether it has set interest rates appropriately on individual loans, based on their performance, and keep records of such. It's not easy to make this sort of retrospective analysis useful in future lending without a very large number of historical loans.

The bottom line

Investors that buy and sell rapidly based on a whiff of information have typically performed a lot worse than those who've just been patient. It would be premature and rather panicky for existing lenders who are already diversified to take any action at this stage.

My best guess is that this will be resolved during September. Await for further information.

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