What is FMPP?
“FMPP is a investment offering in this era of low FD rates and volatile stock-market conditions. It has a completely new algorithm for capital allocation. It has been under development and testing for the past 18 months and it is finally live. FMPP investment plan is an ‘alternative investment avenue’ for all classes of investors, whether retail or HNI,” says Bhavin Patel, Co-founder & CEO of LenDenClub.
Despite multiple rate hikes by the RBI, the 10-year G-Sec rate is 7.33% as on 28 July and bank FD rates are yet to reach the level of 8% annual return. So, is there higher risk in a debt product that offers a much higher return? Are there hidden risks which investors should understand, and should you go for such a debt investment product? Read on to find out.
How does the FMPP work?
P2P is a platform which allows individual investors to lend small ticket size amount to retail borrowers. The new product, launched on a P2P platform, mandates the minimum number of borrowers to which the investing lender’s money need to be diversified is 100. So, if you have Rs 20,000 to invest it will go to at least 100 borrowers. Therefore, the maximum amount of your exposure per borrower will be Rs 200. They have built the algorithm in such a way that it increases the number of borrowers as the lending amount goes up. It theoretically is possible under this product to go for hyper diversification by increasing the number of borrowers in such a way that the lending amount per borrower comes down of Rs 1 per borrower.
How much can you invest?
The minimum investment amount that you need to lend in the new product is Rs 10,000 while the maximum investment amount is Rs 50 lakh.
What are the risks?
Here is a look at the possible risks of FMPP.
The impact of borrowers’ defaults: The most common risk which a lender faces is nonpayment of the borrower amount by the borrower. Just like any other lending institution, P2P lending companies have a sizeable amount of NPAs that cannot be wished away completely. As per Patel the NPA level in LenDenClub has been typically around 2-6%. Any spike in NPA can significantly impact the return and safety of capital. So, investors need to keep this in mind before finalising their investments.
Besides the property credit profiling tool, diversification of lending amount to higher number of borrowers and small ticket size lending per borrower are the broader strategies used by the company to mitigate the NPA risk. As per Patel, they have designed FMPP such that an investment amount is hyper-diversified into a vast pool of borrowers, owing to which the default rate is drastically minimised, thus offering investors risk-mitigated returns.
Earlier a lender had to give at least Rs 500 loan to one borrower, however, now with the new product it is possible to give even Rs 1 rupee loan to a borrower. The P2P lender has also kept the maximum lending amount low for a salaried borrow at Rs 25,000. While the maximum lending amount goes up for a business borrower up to Rs 1.5 lakh. As FMPP will ensure that each lender will have very low exposure to one borrower the company expects it will keep the overall investment safe.
FMP by mutual funds also faced defaults:– Fixed Maturity Plans (FMP) offered by mutual fund houses also offer a way to invest in debt products by locking in the return by holding the securities till maturity. These were considered safe debt investments until they faced defaults four years ago when multiple plans failed to pay back investors on time. However, these defaults were primarily due to few corporate clients with higher loan exposure who could not repay their debt on time. The FMPP offered by LenDenClub differs in terms of nature of borrowers who are diversified in number and have small ticket size. Small ticket size ensures that default by few doesn’t impact the rest of the portfolio.
Riskier borrower segment: The interest rate that is being charged to the borrower is on the higher side which is done by financial institutions typically when there is higher risk in lending. Just like other NBFCs, the interest rate charged from borrowers under P2P lending typically ranges between 18% and 28%. Customers who have good repayment history and good credit score often easily get the loan from banks at a much cheaper rate. So, what kind of borrowers are willing to pay higher interest on their loans?
People borrowing from P2P platforms are mostly those who are either new to credit and without any credit history or find it difficult to access a bank loan for reasons like paperwork, time taken to process the loan, small ticket requirement. Many such borrowers typically get their borrowing needs met by unorganised local moneylenders who typically charge an interest rate of 3-5% per month which translates into an annual rate of 36%-60%. Ease of process and speedy disbursal are also the reasons why some borrower with smaller loan requirement might prefer a P2P loan.
How reliable is the recovery system?
Patel explains that a major part of collection and recovery is IT driven like reminder alerts and follow up by calling bot which also keeps the recovery cost low. He iterates that so far, their recoveries have been robust and they were able to recover Rs 97.5 out of an NPA of Rs 100.
Yet to prove resilience to systemic risks: It has survived the corona pandemic during which the default rate of retail borrowers was higher when LenDenClub faced its highest quarterly default of 6%. However, its difficult to foretell what the future systemic risks could be and how borrowers will behave in case of economic distress.
Should you invest?
FMPP offers an attractive return, but it is not a replacement for FMPs offered by MFs, bank FDs, small saving products and government securities primarily because of the high risk factor. If you understand the risks involved in P2P lending completely and are comfortable with the risk-return dynamics, then you may consider investing in this product. However, it is better to keep your exposure low which can help you boost the return of your overall debt portfolio and give yourself some time to understand the product. If you want to tread more cautiously you can start with short tenure FMPP like 1-2 years. Once you spend time and develop better understanding you may think about going for longer maturity investments.