With a unique number of loans from a large number of loan originators around the world, the Mintos platform offers a great way to build a highly diversified investment loan portfolio. Although diversification is the most important component to achieve long-term financial goals while minimizing risk, the same question remains: How to choose the loans to invest in? Should we pay attention to the profitability of the loan or the financial strength of the originator? Or maybe both factors? Does the profitability of the loan matter if it has a repurchase obligation on the part of the originator?
These are the kind of questions we get and in fact, we see investors discussing these topics at length on the forums. Martins Valters, COO, CFO, and co-founder of Mintos, has chosen to enter this discussion to provide his point of view on the matter.
most important points
– The profitability of the loans is the most important factor for the profitability of the investor. It also has a direct impact on the business activity of an originator.
– The originator plays an important role as collector and provider of the repurchase obligation (where applicable).
– The ability of the originator to meet this obligation depends on the profitability of its loans and the position it occupies in the market since the buyback comes mainly from the extra margin.
In general, when investing in a loan through Mintos, users take positions in the underlying loan made by the originator to the borrower. Currently, this structure is implemented by transferring the receivables on a borrower arising from the loan agreement from the originator to the investor, as established in the assignment agreement. In the future, Mintos loans will be classified as regulated financial instruments called Notes.
Regardless of the investment structure, users will receive principal and interest as each borrower makes payments as set forth in their loan agreements. The portion of the principal received reduces the book value of the users’ investment in the loan, while the portion corresponding to interest and late payments is considered as income for the investors. That is, users earn money on their investments as borrowers repay their loans.
The importance of loan profitability
As a consequence, disciplined repayment by the borrower is the most important aspect of investor returns. When we add an originator to the platform, the first thing we look at is the profitability of the loans. We assess whether, based on its history, we can relatively reliably conclude that the loans granted by the originator will provide an acceptable risk-adjusted return to users of our platform.
In reality, the payment corresponding to the loan must be higher, since the originators have to cover their operating costs (marketing, collection, losses, etc.) as well as obtain a profit margin (you can obtain more information on this in the entry of our blog on the cost structure of short-term loans.
Our due diligence process does not end when the originator joins Mintos. We receive information in real-time through an API on the profitability of loans on the platform and we evaluate this factor for each originator on an ongoing basis.
How do we assess loan performance?
At Mintos, we perform vintage analysis to assess the credit quality of a loan portfolio. This means that we group loans based on an origination or “vintage” period (usually the calendar month) and track their performance: how many loans are paid back, how many delinquent, and how many defaulted. This allows for a better understanding of loan performance over time, as it is not biased by changes in total portfolio size.
As part of the vintage analysis, we look at payouts: the total repayments received of principal, interest, and any other fees on the issued principal. In particular, we look at payout timing and what the total return is as a percentage of the issued capital. Payment time shows the number of months it takes to receive repayments equal to the disbursed loan principal. This measure should correlate closely with the term of the loan. Slow payment and a low total payment may indicate problems with the subscription and/or with the collection process.
Below is an example of a payment analysis for 8-10 month personal loans. As shown in the graph, harvest payout is reaching 100% in 5-7 months and final payout levels at 120% after 9-11 months for all vintages, thus providing an annualized return of around twenty %. Based on the historical track record, we would conclude that loan performance is satisfactory and that such loans should provide adequate risk-adjusted returns to investors and generate a total return sufficient for the loan.
Many of the originators on the Mintos platform operate in multiple countries. In addition, they usually offer more than one type of loan. Each country and each type of product is evaluated separately. This means that the originator can make and collect the best-performing loans in a country, but if the performance in a new country is not adequate or there is not enough history, we will not allow the publication of corresponding credits. to the new country on the platform. We do the same with new loan products. A different approach may also apply to loans made by the same originator in the same country. For example, we can identify the existence of a considerable difference in the profitability of the loans granted to new and existing clients. This is usually common in short-term loans in which the profitability of loans granted to existing customers can be satisfactory, while it is not for new customers. In this case, we would apply restrictions to the originator and only allow them to publish credits granted to existing customers on the platform.
Unfortunately, sometimes borrowers will not be able to meet payment deadlines. This could be due to job loss, poor management of personal finances, or other reasons. Defaults in payments are part of the activity of granting loans. These can vary greatly between different types of loans, different countries, and even between different segments of borrowers of the same type of loan in the same country. However, there is no easy answer to the question “what is the correct level of non-compliance”. Loan profitability must be considered in the context of many other factors, including the interest charged to borrowers.
This brings us to the next question: should investors consider the performance of loans at the individual or portfolio level? In general, when examining loan performance, users should view their loan investments as a portfolio and not as individual positions. The main reason for this is diversification. If a user makes an investment of EUR 1,000 in a loan and the estimated possibility of default is 5%, in the event that this occurs, the investor risks losing the entire amount. However, if the user makes an investment of EUR 1,000 in 100 loans, assuming a position of EUR 10 in each one with the same probability of default, the risk will result in the default of 5 loans. The remaining 95 borrowers will continue to make payments on a regular basis, and the interest received over time will offset the amounts foregone. Even if the expected default rate is the same in both cases, the volatility of returns will be much higher when taking positions in a single loan. Diversification is one of the most important principles when it comes to investing. You can read more about the different ways to diversify your portfolio on our platform in this blog entry.
What happens in the case of loans with a repurchase obligation?
First of all, investors must take into account the profitability of the loan. But, what happens in the case of those with a buyback guarantee? A common misconception is that for these loans, investors take positions in the originators, not the loans, so the return on credit is not important. This is a wrong idea.
To explain why the profitability of the loan remains the most important factor, let’s take a closer look at how the repurchase obligation works. The repurchase obligation is provided by the originator. If there is a default of more than 60 days, the originator will be obligated by contract to repurchase the loan at the face value of the outstanding principal plus accrued interest. Here it is important to understand that the cash flows to cover the repurchase obligation come from the interest margin generated by the originator.
The interest rate spread is the difference between what is charged to borrowers and the amount that is transferred to investors.
Alternatively, the loans could be marketed with a repurchase obligation, but instead of 20% interest, the return would be 8%. In this case, the cash flows to investors would consist of two parts. First of all, the payment received from the borrowers: 90,000 EUR of principal and 8% of this amount, that is, 7,200 EUR in the form of interest. The second part of the cash flows that investors receive are the payments by the originator corresponding to the repurchases: €10,000 of principal (10% of €100,000) plus €800 of accrued interest (8% of €10,000 ) for unpaid loans. The net result is the same as in the case of the loan without repurchase obligation.
Although the funds for the repurchase obligation come from the originator, it is important to mention that these funds are obtained through the extra margin. For loans offered without a buyback obligation, the originator earns 10% interest (30% in total minus 20% transferred to investors), while for those offered with a buyback obligation, the originator earns 22% interest (30% total and 8% passed on to investors). With the additional 12%, the originator gets an extra €10,800 (12% * €90,000), which allows the originator to cover the repurchase obligation and pay investors the €10,000 plus €800 accrued interest corresponding to 60 days or more of non-payment.
When taking into account whether the originator can publish loans with a repurchase obligation on the platform, it is very important for us to verify that this is derived from the extra margin. If we determine that this is not the case, we do not allow the originator to post the loan with a buyback obligation.
In short, even in the case of loans with a repurchase obligation, the profitability of these remains the most important factor. If the loans perform as expected, the originator generates enough margin to cover the repurchase obligation. On the other hand, if the yield on the loan deteriorates and the default rate is higher than expected, the originator could have problems buying back the loans. In the event that the originator fails to meet its repurchase obligation, there is a possibility that investors will not receive their funds. The ability of the buyback provider (which may be the originator or a third party) to execute the buyback is assessed on the “Strength of Buyback” subscore. You can get more information about them Mintos Risk Scoreson our website.
The role of the originator
If the profitability of the loan is the most important thing when investing in them through Mintos, then what role does the originator play and why should investors pay attention to their performance?
The originator plays a fundamental role in the granting and underwriting of loans. If the underwriting standards are of low quality, the loans granted by that originator will have a lower return than expected, which will directly affect the return obtained by the investor. Factors such as the experience of the originator and the management team, their risk management and control capacity, as well as the risk assessment process associated with the guarantee, are essential when evaluating the originator’s granting and subscription processes. Portfolio status and performance are reflected in the “Loan Portfolio Performance” subscore, which is applied to investment opportunities on Mintos.
In addition, the originator plays a key role in managing the loans and collecting payments from the borrower. The quality, stability, and experience of the originator as a provider directly affect the performance of the loan. When you have a stable originator acting as a service, investors can be sure that borrowers’ payments will be collected and distributed in an orderly manner, so the only thing they need to consider is the profitability of the loan. However, if the originator goes out of business and stops collecting payments, there will be interruptions in the transfer of funds to investors. Therefore, we pay special attention to the capacity of the originator as a collector and we analyze the experience of the staff and the management team, the financial position of the company, the procedures and policies, the controls, and the historical performance of the collection processes, in order to be able to reach the conclusion that the originator will be there to collect the funds. Our findings are reflected in the “Loan collector efficiency” subscore.
Finally, in the case of loans with a repurchase obligation, the originator is also usually the provider of the repurchase. In this case, we examine the financial position of the originator to assess whether the providers can be provided with a repurchase obligation. This is especially important early on, as it takes time for the extra interest rate margin to accumulate. As mentioned above, the ability of each originator to meet the repurchase obligation is assessed on the “Strength of Repurchase” subscore.