There are risks associated with all types of investment, and crowdlending is no exception. As with any type of lending, the two main factors in determining whether good returns are sustainable are, firstly, macroeconomic fundamentals, and, secondly, the quality of borrowers’ credit assessments. In this newsletter, we will take a closer look at these factors.
In an internal working paper, Quantrom has forecasted some central economic time series to obtain a better understanding of the likely future development of economic fundamentals in the countries that we invest in.
The COVID-19 recession will have a huge impact on GDP, public-sector deficits and, ultimately, debt-to-GDP ratios.
Figure 1 Current and estimated jump in debt to GDP ratio for some EU countries (source: Eurostat, IMF, DØRS and own calculations)
Debt-to-GDP ratios give an indication of how much governments can help kick-start economies entering recession. Figure 1 clearly shows that Italy in particular will be in a very difficult situation going forward; not only is it expected that real GDP will fall by approx. 10% but also that this will be accompanied by a public-sector deficit in excess of 10% of GDP. These factors combined make it highly likely that Italy’s debt-to-GDP ratio will increase to between 150% and 160% already in 2020.
Selecting countries where macroeconomic fundamentals are favourable is essential to securing a sustainably positive return over a longer period. Eastern EU countries, along with Germany and Denmark, have the best chance of exiting the current recession earlier than most Southern EU countries simply because they have much better starting positions.
Quality of credit assessment
As investors in crowdlending are aware, the individual investor does not assess the credit quality of the borrower; it is the loan originator that credit scores each borrower. It is therefore important that, before committing themselves, investors trust the loan originator’s credit modelling, track record and processes applied to handling late payments.
As such, a loan originator can be compared to the credit department of a traditional bank. However, there is one important difference: a loan originator does not have a stream of deposits to fund loans but must constantly obtain funding from external sources.
Selecting the right loan originators as well as having a high degree of loans with collateral is essential for investors to minimise adverse returns during economic downturns.
No matter how good a credit model and/or loan originator may be, losses will always occur, especially in recessions. Therefore, it is extremely important that interest received on lending is adequate to cover losses.
Real economy interest rates
Crowdlending has higher interest rates because it is part of the real economy. There is risk associated with this type of lending, which is why the risk premium is higher, resulting in higher interest rates. These higher rates should allow for potential losses to be covered, even in a period where the economy enters recession.
While central banks like the ECB keep interest rates negative and support financial markets with huge purchases of government (and to some extent corporate) bonds, they keep interest rates on these bonds artificially low.
With interest rates on most investment-grade bonds at the level of inflation or below, it is obvious that there is no room for any credit losses on such investments.
Crowdlending to the real economy offers the possibility of having an interest-rate margin sufficient to cover losses that will undoubtedly occur in a recession. So yes, it is possible to have sustainable good returns even during a recession with a diversified portfolio of crowdlending loans.
Gustav Jensen Tony Jønsson
Managing Director and Partner Partner
You can invest in crowdlending with Quantrom P2P Lending DAC by subscribing to our profit participation note on our website: Quantrom.com or Quantrom.dk (Danish version) where more information for investors is also available.