What is FMPP?
“FMPP is an investment proposition in this era of low FD rates and volatile stock market conditions. It has a brand new algorithm for capital allocation. It has been under development and testing for the past 18 months and has finally gone live. Bhavin Patel, founder and CEO of LenDenClub says, FMPP investment scheme is an “alternative investment avenue” for all classes of investors, be it retail or HNI.
Despite multiple rate hikes by the RBI, the 10-year G-Sec rate is at 7.33% as on July 28, and bank FD rates are yet to reach the 8% annual return level. So, is there more risk in a debt product that offers much higher returns? Are there any hidden risks that investors should be aware of and should you go for such a debt investment product? Read to find out.
How does FMPP work?
P2P is a platform that allows individual investors to lend small ticket amounts to retail borrowers. The new product, launched on a P2P platform, mandates a minimum number of borrowers to which the investor’s lending money must be diversified. So, if you have Rs 20,000 to invest, it will be given to at least 100 borrowers. Therefore, the maximum exposure per borrower will be Rs.200. They have built the algorithm in such a way that as the loan amount increases, the number of borrowers increases. Theoretically, under this product, one can go towards over-diversification by increasing the number of borrowers, so that the loan amount per borrower is reduced from Rs.1 per borrower.
How much can you invest?
The minimum investment amount you have to lend in the new product is Rs 10,000 while the maximum investment amount is Rs 50 million.
What are the risks?
Here’s a look at the potential risks of FMPP.
Impact of borrower default: The most common risk that a lender faces is the borrower defaulting on the loan amount. Just like any other lending institution, P2P lending companies have significant amount of NPAs which cannot be completely eliminated. According to Patel, the NPA level at LenDenClub has typically been around 2-6%. Any increase in NPA can significantly affect returns and safety of capital. Therefore, investors should keep this in mind before finalizing their investment.
Apart from asset credit profiling tool, diversifying the loan amount to a larger number of borrowers and small ticket lending per borrower are broader strategies used by the company to reduce NPA risk. According to Patel, they designed the FMPP in such a way that the amount invested is spread over a wide pool of borrowers, so the default rate is drastically minimized, thereby giving investors a risk-reduced return.
Earlier, a lender had to lend a minimum of Rs 500 to a borrower, but now with the new product, a borrower can be given a loan of even Rs 1. The P2P lender has also kept the maximum loan amount low at Rs 25,000 for payday loans. While the maximum loan amount for a business borrower is increased to Rs 1.5 lakh. Because the FMPP ensures that each lender will have very little exposure to one borrower, the company expects to keep the overall investment safe.
FMP was also defaulted by mutual funds:– Fixed Maturity Programs (FMP) offered by Mutual Funds also provide a way to invest in debt products by locking in returns by holding the bonds till maturity. These were considered safe debt investments until they defaulted four years ago, as multiple programs failed to repay investors on time. However, these defaults were primarily due to a small number of corporate customers with higher borrowings who could not repay their debt on time. FMPP offered by LenDenClub is different in nature of borrowers who are diverse in number and small ticket size. The small ticket size ensures that the default of a few does not affect the rest of the portfolio.
Risky borrowers section: The interest rate charged to the borrower is on the higher side than that charged by financial institutions, which is usually done when there is more risk involved in lending. Just like other NBFCs, interest rates charged to borrowers under P2P loans are typically between 18% and 28%. Customers with a good repayment history and good credit score often find it easy to get a loan from banks at a much cheaper rate. So, what kind of borrowers are willing to pay more interest on their loans?
People who borrow from P2P platforms are mostly those who are either new to credit and have no credit history or find it difficult to access a bank loan due to reasons such as paperwork, time spent on loan processing, small ticket requirements. Many of these borrowers usually have their borrowing needs met by organized local moneylenders who typically charge an interest rate of 3-5% per month, which translates into an annual rate of 36-60%. The ease of the process and quick payment are also reasons why some borrowers with lower loan needs may prefer P2P loans.
How reliable is the recovery system?
Much of the collection and recovery is based on IT, such as reminder alerts and follow-up with bot calls, which also keeps the cost of recovery down, Patel explains. He reiterates that so far, their recovery has been strong and they have been able to recover Rs 97.5 crore from the Rs 100 crore NPA.
Yet to prove resilience against systemic risks: It has survived the coronavirus pandemic, during which delinquency rates for retail borrowers were higher when LenDenClub hit its highest quarterly delinquency of 6%. However, it is difficult to predict future systemic risks and how borrowers will behave in the event of economic distress.
Should you invest?
FMPP offers attractive returns but is not a substitute for FMPs offered by MFs, bank FDs, small savings products and government securities due to high risk factor. If you fully understand the risks associated with P2P lending and are comfortable with the risk-reward dynamics, you may consider investing in this product. However, it is better to keep your exposure low which can help you increase your total debt yield and give yourself time to understand the product. If you want to tread more cautiously, you can start with a short-term FMPP like 1-2 years. Once you have spent time and gained a better understanding, you may consider investing with longer maturities.