IILM: Funding supplements and investing complements

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A 7-year old peer-to-peer (P2P) lending player has received some funding validation, finally. But is that necessarily a good thing, asks Arundhati in today's edition of Ka-ching!—your Monday morning dossier on fintech and personal finance. Meanwhile, Anand explores the similarities and differences between the highly popular Bharat Bond and the Floating Rate Savings Bond, and how they are not an either-or choice for investors.

A reckoning and an exit

One of the biggest signals of a good product-market fit is a company raising some funding.

Going by that measure, it looks like peer-to-peer lending just found its fit. Last week, LenDenClub raised US$10 million in a Series A round from a clutch of investors, including Artha Venture Fund and Cred's founder Kunal Shah, among others.

Except, this round came a whole seven years after the company was set up. Its pre-Series A round came pretty recently too—in August 2019.

P2P lending companies like LenDenClub are regulated marketplaces that connect individual borrowers to individual lenders; the proposition for lenders being that the interest rate they charge borrowers can translate into great returns. And such platforms have been around for a while now, even if they haven't attracted much investor attention.

So, what is bringing these rather late rounds of funding? The answer seems to be the pull of the market, more than anything else.

As American venture capitalist Marc Andreessen said: "In a great market—a market with lots of real potential customers—the market pulls product out of the startup. The market needs to be fulfilled and the market will be fulfilled, by the first viable product that comes along. The product doesn't need to be great; it just has to basically work. And, the market doesn't care how good the team is, as long as the team can produce that viable product."

Product, meet Market.

Fixed deposit rates offered by banks in India have gone down steadily—from about 8.2% in 2011, to 7.9% in 2014, and finally to around 5% this year. And as the interest one can earn from deposits keeps plummeting, P2P lending becomes more attractive than ever before—offering returns ranging from 10% to as much as 18%.

India has nearly 20 P2P lending platforms with a combined loan book of Rs 5,000 crore (US$660 million), according to this The Economic Times report. Of that, LenDen alone has facilitated Rs 1,200 crore (US$160 million) worth of disbursals, and sees that growing by 5X to US$1 billion worth of loans in the next 18 months, its founder Bhavin Patel told CNBC.

These numbers are probably what got LenDenClub its US$10 million Series A round, among the largest any P2P platform has raised so far. It must have also helped that the company has been making the most of a favourable market. LenDenClub struck partnerships with other financial services platforms such as Cred and Google Pay this year, offering their users the opportunity to lend and borrow from each other.

But a buoyant market risks masking the true nature of the product—in this case, peer-to-peer lending. As we have written in the past, the P2P business has always been a risky proposition for the lender-investors.

The whole concept of peer-to-peer lending is rooted in the fact that when you borrow money from a peer you know, there is trust between the two parties. That trust translates into a repayment commitment, and the relationship you share with that peer invariably becomes the collateral.

In the online world, P2P marketplaces match borrowers with lenders using 'AI/ML' technologies (Artificial Intelligence/Machine Learning). So, it is not so much peer-to-peer but stranger-to-stranger lending. (Side note: I wonder if changing the name to the latter would give users a more accurate representation of the product.)

The ultimate proof of the P2P model, though, lies in its default rates. And LenDenClub's founder says its default rates stand at just 3.95%, and that he expects it to hover between 4-5%. The reason could be because of this:

"The quality of borrowers has gone up because we get a lot of bank/NBFC customers as well these days. There is a lot of awareness about credit now."

Bhavin Patel, founder-CEO of LenDen Club

But then, even non-bank lenders and banks experience higher default rates. In the year ended 2021, bad loans were at 6.4% for NBFCs, 7.8% for banks, and 4.9% for micro finance institutions. And bad loan levels at banks are only expected to rise to as high as 9.8% by March 2022. So, kudos to the company for delivering such 'too good to be true'-type default rates.

That said, even if LenDenClub continues to be an outlier and prevails over the skeptics, all it takes is a few other P2P lending platforms tripping up. After all, that's what we saw with the UK's Zopa.

Zopa was the world's first ever peer-to-peer lending company. And it exited the arena after 16 years in the business last week. The company told customers: "Sadly, over the last few years, customer trust in P2P investing has been damaged by a small number of businesses whose approach led to material losses for customers investing in those platforms. Linked to this, the changing regulation in the sector has made it challenging to grow and remain commercially viable."

Peers, exit stage left.

A case of complementary competition

The frantic hunt for decent returns in India’s low interest-rate environment was on full display last week. The Bharat Bond Exchange Traded Fund (ETF) was oversubscribed by more than 6.2X against its base issue size of Rs 1,000 crore (US$130 million). The strong response is understandable.

With interest rates on most fixed income investments such as bank deposits at a multi-year low of 5%-6%, the indicative pre-tax yield of about 6.87% on the Bharat Bond issue seems a good deal. Also, the issue scores over many other debt funds by minimising two key problems—credit risk and interest rate risk.

With a portfolio consisting of AAA-rated bonds issued by public sector companies, the credit risk (the risk of delay or default in payments) is quite low for the Bharat Bond ETF. And if the ETF is held until maturity, there is also no interest rate risk—the risk that as interest rates rise in the economy, bond prices, and thus the ETF’s portfolio value, will fall.

Bharat Bond ETF is a target maturity fund, a kind of debt fund whose portfolio comprises bonds that mature around a specified target date—around April 2032 for the latest issue. And, including the latest one, it has completed five issues till date,with assets under management (AUM) of over Rs 40,000 crore (US$5.3 billion).

Now, the oversubscription levels in the ETF’s latest issue only underscores the large market for low-risk options that could yield decent returns. But then, there is already another good option that ticks many of the same boxes as the Bharat Bond ETF.

Say hello to Floating Rate Savings Bonds, 2020 (or FRSB).

FRSBs are issued directly by the Reserve Bank of India (RBI) on behalf of the Government of India. With a sovereign guarantee, these bonds offer investors maximum safety and no credit risk. And since the FRSB is a lock-in product for its full tenure of seven years, and not traded on the secondary market, there’s no interest rate risk either.

Besides, the current FRSB interest rate of 7.15% is better than the indicative 6.87% on the Bharat Bond-April 2032.