Cover Story: How P2P financing platforms manage defaults

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on November 5, 2018 - November 11, 2018.
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The peer-to-peer (P2P) financing industry has grown steadily since the Securities Commission Malaysia (SC) issued licences to six platform operators, allowing them to raise funds from the public to provide loans to small and medium enterprises (SMEs), in November 2016.

As at June, the industry had raised RM80.28 million, according to the SC’s website. A total of 1,160 campaigns were launched by 227 issuers (71% of which were from the wholesale and retail sectors) during the period, with a success rate of 100%.

Investors who participated in these campaigns would have earned a decent return. In general, they would have received a simple interest rate of 9% to 13% per annum on each note issued.

But it has not been plain sailing for the P2P financing industry. Several platform operators have already seen defaults on their investment notes.

Funding Societies Malaysia — the largest platform operator in the country — saw its first default in August. Fundaztic has seen four default cases so far while B2B Finpal has had one. At least one of the defaults did not come from the higher risk categories.

Of the six licensed P2P financing platforms, these three are the most active. Some of the defaults were due to unforeseen circumstances such as natural disasters and family emergencies.

Because of these defaults, the platform operators have had to manage the expectations of investors, some of whom have expressed concern about losing their money.

“Investors have been asking us questions since they received notification [of the impending default]. We have been updating them on the progress we have made,” says Wong Kah Meng, CEO of Modalku Ventures Sdn Bhd, which operates Funding Societies.

Kristine Ng, CEO of Peoplender Sdn Bhd, which operates Fundaztic, says the company sends a monthly email to investors to keep them updated on the progress of the default case. Er Chiang Chuan, head of business development and operation at B2B Finpal Sdn Bhd, has been doing the same.

Nevertheless, the three platform operators say investors are generally well aware of the situation. They have accepted the defaults as they were forewarned of the possibility of such cases occurring. They have also followed the platforms’ advice to diversify into various investment notes to mitigate any potential losses.

For instance, Wong says the median investment amount for each note on Funding Societies is about RM1,500. “In fact, many have invested between RM100 and RM300 in each note. Only a few of them have invested more than RM5,000 per note,” he adds.

Ng says Fundaztic has launched several initiatives to encourage investors to diversify their investments. For instance, the platform has shared with its investors a model of how a well-diversified portfolio based on the platform’s existing notes should look like. “We have been telling them to diversify into at least 100 notes. They will lose hardly any money if they do so. We even run a promotion to reward them with RM100 if they reach 100 notes in their investment portfolio,” she adds.

As at Oct 30, Funding Societies had issued 300 notes while Fundaztic and B2B Finpal had issued 342 notes and 1,200 notes respectively.

The default rate across the three platforms remains low, say the operators. Funding Societies has a default rate of 1.04%, according to its website. Fundaztic and B2B Finpal have default rates of 0.6% and less than 0.2% respectively.

Wong says Funding Societies’ current default rate is below its long-term targeted rate of 3% to 5%. Ng says Fundaztic has a higher targeted rate of 5% to 8%.

“We are aiming for 5%. However, the rate could go higher in times of economic crisis. That is the worst-case scenario and we want investors to be prepared,” she adds.

Er says B2B Finpal is aiming at a default rate of less than 2% as the platform leverages its holding company’s internal data to give it insights into companies’ trading activities, revenue and profit.

Wong says defaults are bound to happen and are well anticipated. “It is time for us to focus more on communicating with investors on how we handle these defaults and for investors to be more aware of this.”

Ng concurs. She says investors have been focusing too much on the rate of return and the tenure of each investment note. In general, investors like notes that carry higher interest rates and have tenures of three to six months.

“The tenure of the notes hosted on our platform is 36 months on average. So, we have been telling investors to look beyond the interest rate and into other important issues such as how each platform operator manages defaults,” says Ng.

A key difference in how each platform manages defaults is in how it plans to fund the legal costs for taking action against the issuer. There is also a slight difference in how each platform defines a default.

“Investors should be aware that the recovery process is ongoing even after an investment note is classified as a default. We do not write off bad loans like the banks. That is because investors are the ones who have the right to claim against the companies’ assets if they wind up. Not us,” says Wong.

The other platform operators do not elaborate in detail on how they manage default cases on their official websites. AlixCo says it will do its best to push the issuer to pay off its loan when a default happens and warns that investors could lose all their money.

QuicKash mentions on its website that some notes issued on the platform have a “principal guaranteed element”, which prevents investors from losing all of their principal. Nusa Kapital lists out the steps it will take to manage the defaults, including restructuring funding, liquidating secured assets and legal action.

Personal Wealth talks to Funding Societies, Fundaztic and B2B Finpal to understand how they manage defaults.

Crowdfunded by investors

In August, Funding Societies sent out an email to those who had invested in the defaulted note. The email mentioned that the platform would crowdfund an initial amount of RM5,000 to cover the preliminary legal costs, provided that the matter is uncontested.

The email also said that if the matter is contested, the platform will “reassess the likelihood of success of the case and the further need to crowdfund legal costs”. It added that the participation and contribution of the investors in the crowdfunding exercise “constitute important considerations to the rank of priority of your recovery of the investments you made”.

Funding Societies defines a default as a late payment of more than 90 days in the case of a business term financing note. If it is an invoice financing note, it is 60 days.

Like other platforms, Funding Societies will contact and remind the issuer to make payment a few days before the due date. If payment is not made on time, the platform will contact the issuer to investigate matters.

It will also conduct a site visit to ensure that the business is still running and look into the issuer’s recent credit history to understand its financial position. Representatives of the platform will then meet up with the issuer to negotiate and schedule debt payments on behalf of its investors.

“We need to strike a balance between protecting investors and understanding the situation faced by the issuer. Cash flow is a real issue to many SMEs,” says Wong.

A letter of demand (LOD) will be sent to the issuer once a default is triggered. “This is part of the process and it allows us to better negotiate with the issuer that defaulted on the payment.”

However, the LOD does not mean that the platform intends to bring the issuer to court, says Wong. This only happens if the company remains uncontactable or is not forthcoming in the meeting with the platform operator.

At this stage, the platform operator will hire a debt collection agency to facilitate the debt collection process. The agency will take a cut from the amount that is successfully collected. The rate charged by the agency ranges from 10% to 30% of the total amount, says Wong.

He adds that the cost involving third parties — such as law firms and debt collection agency — is borne by the platform’s investors via a crowdfunding process. “The operation cost, such as conducting site visits and making follow-up calls, is borne by us. We also help investors assess the need to take further legal action and facilitate the whole process. However, we pass on to the investors any third-party fees such as legal and debt collection costs.

“The investors are the ones who get the returns. Hence, they are also taking the [default] risk [and bearing the costs]. The legal action and debt collection agency are there to help investors recover the debt, not for us as a platform operator.

“Another example is like how banks give out loans to businesses. When businesses default on their loans, the banks have to pay for the legal and debt collection services.”

Wong says further legal action will be taken once investors have fully crowdfunded the amount of money needed.

Platform pays legal costs first

Fundaztic’s Ng says that of the four defaulted notes, three issuers are currently negotiating a new payment schedule while one remains uncontactable. “Two of the notes were issued by a salon operator. The reason for the default is that the owner spent some of the money on a medical emergency as a member of her family was admitted to hospital,” she adds.

“She tried her best and did make payment on a note that defaulted earlier. However, another note defaulted after that. She remains contactable and the business is still operating.”

Ng says the other two issuers who defaulted are involved in the advertising and telecommunications business. “The telecommunications business is the only case of a default gone bad. The issuer is uncontactable, so we will take legal action,” she adds.

The platform operator primarily hosts business term financing notes. It defines defaults as late payments of more than 60 days by the issuers. This is 30 days earlier than the common industry practice.

That is because the platform prefers to deal with default cases sooner rather than later, says Ng. “Our platform funds many micro-SMEs (MSMEs) and sole proprietors, unlike other platforms, which fund more established companies. When these MSMEs fail to pay their debt in the second month, there is a high chance that they will not be able to pay in the third month. We prefer to deal with the default situation faster and more efficiently.”

Ng says the platform could also hire a debt collection agency to facilitate the debt recovery process, depending on the complexity of the case.

Like the other platforms, Fundaztic will remind issuers when their payment date approaches. When a default happens, it will contact the issuer to negotiate and structure a debt payment schedule.

“How contactable the issuers are is crucial. We will only take legal action if the issuers become uncontactable,” says Ng.

Legal action, such as the issuance of a legal notice of demand (LND) or legal notice of recall (LNR), will be taken when an issuer no longer makes payments on the defaulted loan or has lost the ability to pay off the loan. Legal action will also be taken if the issuers are no longer cooperative and sever the relationship with the platform.

“If the issuance of LNR is not sufficient, a court summons will be instituted to obtain a judgment. Once obtained, the enforcement of the judgment will depend on the effectiveness of the different modes of legal execution,” says Ng.

What distinguishes Fundaztic from Funding Societies is that the former will fork out the legal costs first when a default happens. It will claim back the sum after the debt payment has been recovered.

“We will pay and pursue legal action [when a default happens] and investors do not need to pay us anything until we have successfully recovered the defaulted payment,” says Ng.

That is why the platform is prudent in keeping its default rate between its long-term targeted rate of 5% as each default case means additional cost to the platform until the case is settled, she adds.

Ng says P2P financing platforms should not hesitate to take legal action against issuers when required. She adds that if platforms do not pursue legal action when necessary, some issuers may think the platform will go easy on them in the event of a default. “[As a result,] your platform could attract issuers of lower quality instead of good ones.”

Ng says the platform recently decided to feed the payment records of its issuers to credit rating agencies such as Credit Bureau Malaysia, CTOS Data Systems Sdn Bhd and RAM Credit Information Sdn Bhd. Under local data privacy laws, it is allowed to do so.

“We hope this will give us a higher chance of recovering defaulted loans. How? Most of the issuers — across all [P2P financing] platforms — would have been given some credit by the banks, be it in their personal capacity or under the name of their companies,” she says.

“So, when we provide their payment records to the credit rating agencies, we hope the banks are prompted [by the credit rating agencies] when our issuers default on their payment. We could have a higher chance of recovering the defaulted amount if the banks also take action against them.”


Legal costs borne by issuers

B2B Finpal mainly hosts invoice financing notes with tenures of three to six months. The issuers are clients of B2B Commerce Sdn Bhd, the parent of the platform operator.

B2B Commerce runs an online platform that facilitates the buying and selling of goods between retailers and suppliers. The retailers are mainly big industry players such as Parkson, Tesco and 7-Eleven while the suppliers that raise funds via the platform are SMEs that supply fast-moving consumer goods to the retailers.

B2B Finpal’s Er says the platform defines defaults as late payments of more than 90 days. Should the operator need to take legal action, however, the cost is mainly borne by the issuers, he adds.

The platform will distribute 90% of the total amount raised by the issuer while retaining 8.5% as a reserve fund for other purposes, including legal action when a default happens. For instance, when the issuer raises RM100,000, the platform operator will disburse RM90,000 to the issuer and keep RM8,500 in a reserve fund.

“Of the total amount raised, we deduct another 1.5% as processing fee, which we charge all issuers for helping them raise funds,” says Er.

The reserve fund is also used when late payment occurs. “There have been times when the issuer passed us a cheque on the 60th day. We need another two to three days to process it,” he says.

The reserve fund will be distributed to the issuers once they pay off their loans, says Er.

B2B Finpal is in the process of recovering a defaulted payment by bringing the issuer to court. Er says the issuer had defaulted on its payment due to a major flood that affected the country’s northern states last year.

“The issuer runs a fresh food business and it was affected as well. The business had cash-flow issues. We met up and restructured the payments, but the issuer was not consistent in making the payments. To safeguard the interests of investors, we had no choice but to take the matter to court,” he adds.

“Initially, we served the person an LOD. Then, we went to court to seek a judgment that would allow us to advertise in the newspapers stating that the issuer owed us a sum of money, to notify the public. We also informed him about the court date.

“Eventually, the issuer appeared in court. He admitted to the debt owed and agreed to pay the sum owed to us plus a penalty that we impose on note defaulters over a six-month period.”

Er says the whole legal process took about a month. “However, the process and time taken would have been longer if the issuer had decided to hire a lawyer to defend himself.”

The platform operator also provides credit rating agencies with the payment records of issuers to discourage them from defaulting. The issuers are informed in advance of the release of such information.

“We do not do it if those who have defaulted are willing to discuss the matter and reschedule their payments. We only do it when it is necessary. It is a last resort,” says Er.