Creditstar, ID Finance, and IDF Eurasia scores suspended from Welfio
We hope you enjoyed our latest blog post Risk Scoring update: Twino Loan Originators' scores suspended from Welfio.
Following the same note, here we will explain our reasoning behind the suspension of Creditstar, ID Finance, and IDF Eurasia scores on Welfio, as well as cover some of the potential causes behind the cash flow troubles that these companies might be facing right now.
Since the beginning of the war in Ukraine, we have been monitoring the situation with all lending companies especially carefully. Throughout this period, 3 lending companies (Creditstar, ID Finance, and IDF Eurasia) on Mintos have stood out with significantly rising pending payments. As the pending payments’ proportion of the total listed portfolio crossed a 10% threshold a while ago, we saw an increased uncertainty surrounding the ability of these companies to cover current and future liabilities to loan investors. As the mounting uncertainty does not allow us to properly assess the actual risk levels of the given lending companies, we took a cautionary measure and suspended their scores from Welfio scoring.
Let us explain why pending payments are so important and what could potentially have led to such dramatic increases.
What do pending payments even mean?
While most of you might know this, let us start by covering some basics.
As per Mintos, pending payments represent money that has been repaid by the borrower and is in the process of being credited to the investor’s account.
While Mintos motivates the need for pending payments by highlighting international payment issues, we believe there can be much more to it and it has to do with the primary purpose of the lending companies' participation in crowdlending marketplaces.
Importance of pending payments
At the end of the day Mintos, Peerberry, and other similar marketplaces are just another source of debt financing for lending companies. Loan originators use marketplaces to fund their operations and fuel their growth.
While there is nothing wrong with that per se, over-reliance on crowdlending can potentially become quite risky. Looking at history, the supply of funds by investors through loan marketplaces has been relatively volatile (especially in periods of general uncertainty). As a result, the funding from loan marketplaces can quickly and unexpectedly drop, and lending companies that are overly dependent on it, can find themselves in huge trouble and unable to cover their short-term liabilities. Even if they are very strong operationally.
This typically leads to increasing pending payments (as the company cannot settle its obligations towards investors). This increase, especially if it spirals out of control, can frequently lead to company defaults and funds in recovery.
Now, what exactly could have happened to Creditstar, ID Finance, and IDF Eurasia? Why did their pending payments get out of hand? While we cannot know the actual reasons behind this, there are several factors that might have been at play. Let's look at two that typically lead to pending payment issues.
What could be at play?
1. Decreased demand for loans (or notes) from investors
It is no secret that the Russian invasion caused investors to be more cautious and reevaluate their investment choices. P2P lending not being an exception, many investors (especially on the Mintos platform that also transitioned to a new setup), reduced their exposure to loans and investments in general.
As a result, way less funding became available to the lending companies. They tried (and still do) to compensate for this with increased interest rates and cashbacks, however, some of the measures might have come too late, it takes a while to get the investors going, and the market is only as big as it is. In many cases, this can be the primary problem.
2. Borrower and investment cash flow mismatch
Compared to other sources of funding, for many lending companies, p2p lending really stands out because the debt repayments to investors are typically aligned with the cash inflows from the borrowers. This is so because p2p investments' repayment schedule is frequently directly tied to the loan repayment schedule of the borrowers.
Consequently, whenever the borrower makes a loan repayment, the company has actual possession of the paid funds and it can forward them to the investors. This leaves worries about covering debt capital from profits or other means to the side as, in most cases, the p2p lending cash flows are aligned with the loan portfolio cash flows.
Sounds pretty convenient? Because it is. Most of the time.
The time when lending companies typically have to cover p2p lending debt independently from the borrower's cash flows is when their buyback obligations are activated. On most platforms, the buyback obligations take effect when a loan is 60+ days late. If only a tiny (or at least stable) proportion of the overall loans goes into buyback, lending companies can easily cover the arising debt from their funds.
The problems start if the quality of the companies' loan portfolios worsens due to increased global economic uncertainty, rising energy prices, or something else. As the lenders are obliged to rebuy the late loans, which are now growing in amount, the cash flow from actual borrower repayments grows further apart from the cash flows to p2p investors.
One way the lenders try to fight is by offering restructuring and extension options to their clients. While this can work in the short term, frequently loans get extended for 6 times or more, which means that by Mintos rules, the lending companies are obliged to rebuy the loans regardless of the actual situation with the borrower repayments.
Why is this important? Due to the events described above a significant amount of money loans are being rebought from investors. The borrowers, however, haven't repaid the money yet, thus a mismatch of cash flows between the investors and the borrowers can form. In general, there is always some mismatch even in normal market conditions, however, in uncertain times like now the gap can expand quickly.
This causes lending companies to use funds other than from borrower repayments to repay the obligations to investors. If a lending company is tight on capital, very leveraged, or has reinvested most profits back into the loan portfolio, this can very quickly become extremely difficult.
The chart below shows the pending payment statistics from Creditstar, ID Finance, and IDF Eurasia. We can clearly see how the pending payments started rapidly increasing after the war in Ukraine. Currently, Creditstar has 22% of their total loan outstanding loans in pending payments, IDF Eurasia - has 23%, and, lastly, ID Finance has a terrifying 52% of their portfolio listed on Mintos in pending payments.
An interesting trend that we can observe is that the biggest increases in pending payments took place approximately 2-3 months after the invasion started which is about the time when the buyback obligations could have started to kick in. This means that even under very dire geopolitical and economic circumstances, loan investors still can take precautionary measures if they feel that 1) the investor demand for loans can reduce significantly and/or 2) a mismatch between borrower repayments and payments to investors can widen due do deteriorating loan portfolio quality and following obligations for buybacks.
Needless to say, the high pending payments do not imply that the lending companies are in actual financial trouble or that they will default on their obligations to investors. We simply see that having a substantial part of the portfolio in pending payments could be a sign of precaution that urged you to monitor the situation more closely. Given the uncertainty surrounding this situation, we at Welfio find it very difficult to assess the current risks associated with investing in these companies and, hence, have made the decision to suspend their risk scores from Welfio scoring.
We hope this helps understand the situation better and perhaps protect your portfolio better in the future shall similar circumstances occur.