While we have hardy systems in place, we can't guarantee that peer-to-peer lending is 100% risk-free. We believe in full transparency so here are the potential pit-falls. Don't forget to also take a look at how we manage risk.
The risk of borrower default is one of the most significant risks for investors in peer-to-peer loans. Borrower default can occur for a variety of reasons including the borrower falling on hard times, death or serious illness and on occasion fraudulent behaviour. Broader environmental (macro) factors such as recessions etc. can also influence the prevalence of borrower default.
The factors that help mitigate this risk include our credit decisioning processes, the security that may be associated with the individual loans underwritten, our Reserve Fund model and the Trustees' ability to socialise any credit losses across all investors in an investment class.
If a borrower defaults on their loan, we may act to collect overdue payments, including appointing an external collections agency or using available legal remedies, including where appropriate, court action. If the loan is secured, collection actions may include the secured asset being repossessed or sold. There is however no guarantee that any security available to a loan or our recovery actions will be sufficient to fully recover the outstanding balance of that loan and the fees associated with the collection of the debt.
The reserve fund model which within New Zealand is unique to Squirrel, has been put in place to help protect your investments in the event of a late borrower repayment or borrower default. Each Reserve Fund is funded by applying a reserve levy to the borrower interest rate which is aligned to the borrower risk grade and corresponding modelled probability of default.
The reserve fund is not an insurance product however and we cannot guarantee or warrant that it will have enough funds available to it to enable you to be fully compensated in either of these events. For further detail about how our reserve funds operate, including what would happen if a reserve fund was depleted, refer to our Reserve Fund Policy.
Investments into peer-to-peer loans are fixed-term investments and as such the ability for an investor to liquidate an investment at will is inherently more limited than an on-call investment.
Our platform includes a secondary market which provides investors the opportunity to transfer their investments to other investors. The ability to transfer your investment(s) is however completely dependent on another investor being willing to take over your investment for the remainder of its term on the same investment terms, including the interest rate, that you signed up to. If a willing investor cannot be found, you will not be able to transfer your interest in a loan and may be required to remain invested in that loan for its full term.
You should therefore ensure that you can afford to have your money committed for the full term of the loan(s) that you invest into.
Your ability to make an investment into a peer-to-peer loan is restricted by the:
Whilst we offer an automatic re-investment facility, the factors above will ultimately determine how long it takes to get your funds invested and therefore generating a return.
The consequence of a limited availability of loans that meet your investment criteria is that your uninvested money may remain in your on-call account not generating an investment return for an extended period.
Lending in the higher interest rate categories typically see high prepayment rates. As mentioned above, our experience suggests that prepayment rates can be in the vicinity of 30-40% per annum for Personal Loans and 20-30% per annum for Home Loans and Construction Loans. As a result of this, it should not be unexpected to see a reasonable proportion of the investments you make to fully repay before the original investment term is reached.
In addition to the inherently high prepayment rate with higher-interest lending, one of the key features of our lending products is that borrowers on the platform can repay their loans at any time without penalty and on occasion we even assist the borrower to refinance their loan if that makes sense for the borrower.
If a loan is repaid early, the outstanding principal and interest (accrued up until the repayment date) is transferred to the investor(s) in that loan as soon as the early repayment is received.
The consequence of early repayments is that the investor(s) in those loans have their principal returned before the original investment term expires and they therefore do not receive the amount of interest income that they would have received if the loan had continued for its full term. Of course, investors are welcome to reinvest in new loans to keep their money working for them.
Our platform is entirely online and as such this exposes us to threat of cyber fraud. In recognition of this risk our IT team have gone to great lengths to make the platform secure, including undertaking periodic external IT security audits. Should a cyber-attack manage to breach our walls, your money has the additional protection of knowing that all funds in the platform are held in a trust and can only be transferred out of the platform using our online banking system with dual signing authority.
As part of our licence to operate, we also maintain a disaster recovery and termination plan and we have insurances in place to protect against both cyber- crime and fraud.
The peer-to-peer industry and legislation in New Zealand are still relatively new and regulators such as the Financial Markets Authority and Commerce Commission, and the Courts, are still developing their positions on how to apply the law.
If a regulator were to take a position which is inconsistent with our current practice, it could affect how we are able to operate our business and, in an extreme case such as in relation to consumer credit legislation, the ability to enforce loans. To keep abreast of current legislation and its interpretation we regularly seek legal advice from experts in this field.
There are several conditions that Squirrel must satisfy to maintain its licence to operate as a peer-to-peer lender. Failure to comply with those conditions could see Squirrel’s licence removed or its conditions changed. We have however put a strong governance framework in place and are regularly audited to ensure we do not breach any of our licensing conditions.
If Squirrel was placed into receivership, we have set aside funds to help manage the run-off of the loan book by way of a bank bond for the benefit of the platforms trustee. This bond (plus access to the ongoing Squirrel margin on Loan repayments) is in place to ensure an appointed third party can continue to administer the collection of borrower repayments and payments to investors until such time the loan book has run-off.