This article was originally written for Target, the loan and mortgage servicing group.
An online lending platform, in its purest form, matches lenders with borrowers. It earns its cut from making a good match, documenting the loans well, managing collections and making payments to investors efficiently. This is its loan servicing function for which lenders pay a fee.
Institutional investors understand that loan servicing done well is credit enhancing. You just need to look at the securitisation market to see the emphasis rating agencies put on the ability of the chosen loan servicer to service the underlying loans. Loans originated on an online lending platform are just the same as any other loans. The value a loan portfolio has to any lender – whether a private individual or an institutional investor – is enhanced by how well the online lending platform services that portfolio.
Again, drawing on the similarities with standard securitisation structures, online lending platform need to show they have addressed the risk of a failure in their organisation, resulting in them becoming unable to service the loans. This risk needs to be mitigated to preserve the value in the loans originated. The Financial Conduct Authority (FCA) is specifically looking into what back-up provision an online lending platform needs to have, to ensure its loan book is run off with as little disruption as possible if the platform fails.
The FCA wants to see that a platform has made provision for the servicing of the loans it originated if it can no longer do the job. The more established platforms and especially those backed by institutional funding, are addressing this through back-up servicing arrangements with a dedicated loan servicer, such as Target.
We have been actively working with platforms and loan servicers to put in place back-up servicing arrangements. From our experience, we now understand that the following four focus areas can help online lending platforms to put in place effective back-up servicing arrangements, and in turn increase the platform’s attractiveness to institutional investors:
- full and frank disclosure – if a platform can give a clear and precise description of its own business model, systems and processes, it is more likely to attract a reputable loan servicer to stand behind it at a proportionate cost.
- thorough diligence – the diligence undertaken by both the loan servicer and the platform often acts as a way of stress testing whether a platform can efficiently service and profit from the loans it originates. Loan servicers providing back-up solutions will only want to work with those platforms which can evidence that credit, reputational and fraud risk are managed effectively.
- well drafted documentation – there are many different models of online lending platforms servicing , and therefore documenting the back-up arrangements for a platform can be complex. The process of agreeing the back-up servicing agreement can be a way to really understand how a platform runs its business and what the key stresses are to it which is in no doubt valuable to both parties.
- an open dialogue – the online lending sector is a rapidly changing environment, with platforms frequently launching new products, investing in new technology, creating new sources of funding and enhancing platform users’ overall experience. This results in the need for the back-up arrangements to be adaptable. Periodic reviews by the back-up loan servicer and an open dialogue are key to making the back-up servicing arrangement an effective solution for an online lending platform.
We have seen growing demand for back-up loan servicing solutions, mainly due to the FCA’s requirement for online lending platforms to have a back-up plan and the advent of institutional funding into online lending platforms. Primary servicing at the platform level is also a growing market for dedicated loan servicers. The online lending market strives for efficiency and rapidly increasing scale to counterbalance its relatively expensive cost of funds. Back-up servicing arrangements have arguably moved from being a “nice to have” to being an essential part of a platform’s drive to achieve that scale and to enhance their users’ overall experience.