From time to time you may find that loans in your portfolio are non-performing – don’t panic, it’s a normal part of the lending experience and shouldn’t necessarily be a cause for concern.
We refer to a loan which is late paying, past the loan maturity date or in collection as ‘non-performing’. Interest accrues for these loans but is not paid until the loan is back on track or a resolution is reached with the borrower. If the borrower is unable to repay the loan and interest in full, there is a chance you may lose capital and interest.
The most common reason for loan non-performance is that it passes its maturity date and is awaiting refinancing. Once these “over term” loans have been refinanced, borrowers repay Choice, and then investors’ capital is redeemed, making it available for the investor to withdraw again. Historically, we’ve seen that around 80% of loans that go over term are redeemed within 60 days of the maturity date. We outline below why loans become non-performing.
As of 12 June 2019, 94 out of the 633 loans on the platform have become non-performing. Of these, 70 are now back on track or have been redeemed, and in most cases have taken a matter of weeks to do so. Currently, 24 out of the 376 live loans are non-performing (6.4% of the loan book). Of course, past performance is no guarantee of future results.
All loans are subject to strict underwriting criteria by the Octopus Real Estate team. However, it’s important to remember that as Octopus Choice invests in loans backed by property. Should a property need to be sold or refinanced to repay a loan, the amount recovered could be affected by market conditions.
Mitigating the risks
Of course, while we can’t eliminate the risks of investing in peer to peer, we have taken steps to mitigate them. All loans on the Octopus Choice platform are made at conservative loan-to-values (LTVs) – meaning there’s a substantial cushion if there was a fall in the value of the property. The maximum LTV for residential property is 76%, while for commercial it’s 65% – and the current average across the loan book is 64%.
The headroom is such that even if we had to sell the property to recover funds, we aim to reclaim not only the investment amount, but the interest payable, too. Remember, you’d receive all the capital interest recovered before Octopus receives theirs.
In other words, even though you might not be earning interest on the loan today, we’d aim to pay it to you later once the loans are back on track or as much of the funds have been recovered as possible.
In some instances, we may be unable to recover all the interest or the capital if a loan were to go into collection. It’s worth remembering that the value of an investment in Octopus Choice and any income from it can fall as well as rise. So, you may not get back the full amount you invested. To understand the risks better, click here.
Accessing your capital
You can make a request to withdraw at any time and we won’t charge you a fee for doing so. However, instant access to all your invested capital can’t be guaranteed for two main reasons.
When you request a withdrawal, your loan parts must be sold to other investors or to Octopus first.
You won’t be able to withdraw money that’s invested in any non-performing loans until they subsequently recover, or an alternative resolution is reached with the borrower. It’s therefore important that you’re comfortable that a portion of your portfolio may be unavailable to withdraw at any one time – even if most of it may be accessible within a few working days. Historically, between 2% and 7% of the loan book (by value) has been non-performing at any time.
Why do loans become non-performing?
There are a few ways in which a loan can become non-performing. We thought it would be useful to explain them and give a sense of likely recovery timeframes for each. Though of course we can’t make any guarantees as to exactly how long it will take.
1. Late-paying loans
A loan is deemed late paying when a borrower misses two consecutive interest payments. Octopus Real Estate first action is to notify the borrower and their solicitor of our intention to instruct lawyers. In our experience, the borrower will usually get back on track within a month or two, without having to escalate the issue beyond the threat of taking legal action.
You won’t be paid interest on this loan while it’s non-performing. However, you will be the first to be repaid once the loan is back on track.
Octopus Real Estates’ rigorous lending criteria often stipulates that the property is generating income before the loan is made, but unforeseen circumstances will sometimes arise. There could be various reasons a loan might become late paying. For example, if a tenant of a property is suddenly unable to pay their rent, the borrower may not have the cash flow available to make their repayments.
Octopus Real Estate will work closely with any borrower in trouble to help them get back on track. However, in the minority of cases when a borrower fails to repay what is owed, it is then that Octopus Real Estate will initiate legal proceedings. If necessary, they’ll repossess the property to recover all or as much as possible of what’s owed to you. In this instance, the loan status will change to ‘in collection’ (see below).
2. Over-term loans
A loan becomes ‘over term’ when a borrower reaches the end of the loan period, without having paid back the full amount of money that is owed (this includes capital, any interest still due, and fees).
As above, Octopus Real Estate will do what they can to make sure you get the interest you’re owed. But while a loan is over term you won’t receive interest payments or be able to access any money invested in it.
The Octopus Real Estate team work closely with any borrower that’s worried about going over term, but it can still happen. In the worst-case scenario, if the borrower is unable to settle the outstanding amount, they’ll appoint a receiver to assist in recovering all or as much of what’s owed to you as possible.
But it often won’t get to this point. In our experience, it usually takes around three months for a borrower to arrange repayment – although, again, this can’t be guaranteed.
It’s often the result of an unforeseen event that can easily be rectified. For example, a borrower that was expecting to sell the property might have seen the sale fall through. Instead, they may decide to refinance, which can take some time, although there won’t have to be a lengthy legal process to recover the property.
3. Loans in collection
If a loan has gone into collection, it means Octopus Real Estate have taken charge of the property in order to sell it and recover what is owed.
As anyone who has sold a property will tell you, this can take some time to complete – and is therefore a last resort. However, the conservative LTV acts as a cushion to reduce the chance of capital or interest being lost. Remember, Octopus also invests 5% alongside investors in every loan and within our model, investors are repaid first.
Despite this, there is of course no guarantee that you’d get back what’s owed to you. As ever, it’s possible you could get back less than you initially put in.
So, what’s next?
To find out if any of the loans you’re invested in are non-performing, you can log into your account. In the loan details, you’ll see exactly which loans are non-performing and how we’re working to get them back in track (this feature is not available on the app). Of course, though, we’re always here to help if you have any other questions. Just drop us an email at email@example.com.
Finally, it’s important to remember that peer-to-peer investments aren’t protected by the Financial Services Compensation Scheme (FSCS).