Buyback for P2P loans, how does it work?

When choosing a P2P platform to invest into, buyback has become a significant vote in favour of some sites. Others, however, are a bit suspicious and wonder how guaranteed return makes economic sense. This is a topic that I get a fair bit of questions about, and I was in the camp of those wondering where the catch was at start as well. However, this is the reason you do background checks – to figure out how the economic model of certain sites works and whether or not it makes sense.

Different options of buyback

Currently I invest on three different P2P sites that offer a buyback option. The Latvian sites Twino and Mintos offer a buyback campaign that purchases back delinquent loans. For Mintos the deadline is 60 days, for Twino the deadline is 30 days delinquent. (This seems to be a bit earlier at times, since I’ve been seen buybacks from both sites already.) The Estonian site Omaraha also offers a kind of a buyback – for them it’s a principal buyback in the value of ~60% of the remaining principal. Both Twino and Mintos however also pay out the interest you have earned. So, in theory for both of those sites it’s as near to guaranteed return as it can get in P2P, how does it make financial sense?

How do the numbers work?

The biggest question that you should be asking when it comes to buyback is this – how does the business still make a profit? This is the key issue – they have to be making profit off the loans otherwise the buyback would not be sustainable in case of an economic downturn. This means that despite the fact that some of the profits earned off loans are paid out to investors, the business still earns some.buyback For both the Latvian sites the % you earn is in the ranges of 12-15% return on a yearly basis. This means that clearly the actual loan rate for the people taking out the loans has to be significantly higher to justify such a payout model. For Twino the loans are payday loans, meaning the interest rates are likely to reach up to 100%, for Mintos some of the loans are for example car loans, that are likely to go up to 30% per year. In addition to the overhead interest any and all penalties, extra interest and fees are also placed on top of the interest that you earn as an investor. This means that buyback is viable only for loans that have a high enough margin for the loan originators to cover (un)expected losses and wait for recovery to happen on defaulted loans. For Omaraha the interest rates on certain groups aren’t too high, which explains the buyback being partial – allowing a return of only a part of the principal. Bondora for example is against buyback on principal, but theoretically it could be implemented with good data workings provided they were interested in doing even more of the recovery (which they are not at this point in seems). Another important note here is the length of the loan – for Twino getting investors involved would be near impossible without buyback due to the short term of the loans, since waiting for recovery would be disproportionately long compared to the loan terms on the site.

Risks associated with buyback

In the world of consumer credit it’s common for companies to finance themselves using investors’ money. This is how most SMS-loan type businesses work – they release bonds at about 10-12% rates that finance their loan origination. Compared to the buyback process (and financing loans through the marketplace with investors’ money) releasing bonds is actually rather expensive – take into account all the fees for lawyers, documentation etc. Plus, financing the loans through a marketplace allows the businesses only use as much of the supply as they need, meaning they don’t pay out interest on money that’s still not used, actually probably making offering the buyback cheaper than other methods of financing their loan portfolio.

However, this does not eliminate risks completely. Firstly, in case of the loan originator going under you’re still in trouble. Secondly, even with the best laid plans, issues might happen – for example in case of a crisis buyback may be (temporarily) cancelled. Thirdly, this is an untested way of financing – issues may occur that none of us have been able to predict.

This means that you should still firstly diversify between different loan originators, still diversify between loans themselves and diversify across different investments and take a critical look at the background of the originators to see if their financial models work out. However, this might just be something that will take more ground in the world of P2P – reducing risks is one thing that might motivate more risk averse investors to try out P2P investments.