It has been a big week for industry news. Yesterday, Funding Circle USA launched their fractional marketplace aimed at individual accredited investors. In what is the first offering of its kind in this country investors can now invest directly in fractions of small business loans.
Until now, Funding Circle investors could invest in whole loans or through Funding Circle’s own fund: FC Partners Fund 1 (full disclosure: Lend Academy Investments P2P Fund is an investor in FC Partners Fund 1). And to invest in whole loans that average around $100,000 you need to have a very large portfolio to be fully diversified.
A Minimum Investment of $1,000 per Loan
I should point out immediately that we are not talking about $25 loan fractions here. Funding Circle is only open to accredited investors and they have set the minimum investment to $1,000 per loan. They have also set the minimum account total to $50,000.
I chatted with Sam Hodges, the co-founder and U.S. managing director of Funding Circle, earlier this week about this news. He told me that Funding Circle currently has 500 investors who have expressed interest in their fractional product and he expects to grow that number to many thousands by the end of the year.
About Funding Circle’s Fractional Marketplace
Like Lending Club and Prosper, Funding Circle has a whole loan and a fractional loan marketplace. But for investors used to seeing hundreds of available loans on fractional platforms you will need to adjust your expectations here. As of this writing there are three loans available for investors. So, it will take some time to build up a diversified portfolio.
Having said that loan volume at Funding Circle is increasing rapidly. They did just under $10 million in loans in December and will do more than that this month. So, we should see loan availability continue to increase.
Loans are added to the marketplace three days a week on Monday, Wednesday and Friday. While Funding Circle does have an API it is only functional for investing through the whole loan marketplace today. There is no way to invest programmatically through the fractional marketplace (although that capability is coming) so there is no mad rush when loans are added.
Investors do get quite a bit of detail on each company. Funding Circle shares a short description, location, years in business, employees, industry, company financials, personal FICO of owner/s and information on bankruptcies if any. Company name and the names of the owners are not disclosed.
There are four loan grades at Funding Circle: A+, A, B, C with expected annual loan losses ranging from 0.6% for A+ loans to 3.3% for C-grade loans. The average interest rate is in the low teens and the average loss rate is in the low single digits which means expected returns are in the double digits.
To execute the fractional transactions Funding Circle has established a broker dealer called Funding Circle Securities. The notes themselves are issued by Funding Circle Notes Program, LLC. Investors can setup taxable accounts or invest through an IRA (either traditional or Roth).
My Thoughts
I am very happy that Funding Circle has finally launched a fractional marketplace for investors. They have been very successful attracting investors in the UK and I think they will do very well here. I would obviously like to see them open to all investors, not just those who are accredited, and I think a lower minimum investment would be helpful, too.
These changes are likely coming although not any time soon. While Funding Circle would love to be available to regular investors, like Lending Club and Prosper, the legal and administrative costs for establishing this are too great.
So, this is a good first step. For accredited investors with six figures or more in consumer P2P loans Funding Circle allows for added diversification with exposure to small businesses. Not only that but you can feel good about the fact that you are directly helping American small business.
Investors should keep in mind, of course, that even with the expected loss rates being low this kind of investing carries significant risk and everyone should conduct their own due diligence. This article is provided for information purposes only and should not be considered investment advice.
Allowing fractional business loans is a really good move for Funding Circle. Did FC mention why they set the minimum investment to $1,000 in each loan?
Minimum investment of $1,000 in each loan and minimum account value of $50,000 doesn’t make sense from lender perspective. You need at least 250 notes to have a diversified portfolio, that is at least $250,000 account value at $1,000 per loan or minimum investment of $200 in each loan at $50,000 account value. What is the typical account value of accredited investors (excluding institutions) at FC?
It would have been in FC’s interest to get their lenders diversified as quickly as possible. In any case, an Interesting development for other business loan platforms to consider.
I don’t know what was behind the decision to make the minimum $1,000 per loan. And clearly $250K would be an ideal diversification but I think $100,000 would be adequate for at least moderate diversification. I would have probably set the minimum at $100K because as you say you want investors to become diversified quickly.
The FC fractional marketplace has been open for a limited # of people since October 2014. I started investing there at that time. My thoughts:
Although FC gets a lot of press, FC USA is very much a startup.
Loan volume on the fractional market has been extremely small. They post loans 3 times/week, and each batch has been between 0 and 4 loans. I haven’t kept track, but I suspect the average is about 1.5 . So there is not much selection.
There are many low quality loans. On many (probably most) loans the interest coverage is below 1 (in other words the business can’t afford the loan, unless the loan causes business to improve), and on many (perhaps most) loans the asset coverage is below zero.
There is not enough history to gain any understanding of their underwriting performance from statistics. You have to take a wild leap of faith and imagine that they know what they’re doing.
I’m in there trying it and learning, and I’m sure others may want to be also, but beware that there are risks here that are entirely different than Lendingclub or Prosper.
I’m glad Fred you mentioned it – a close friend had similar thoughts a few weeks ago. He also logged in (by mistake? atleast thats what he told me he thought it us FC US) at their UK platform and told me an interesting fact – their yield there was ~5%? Is that standard in UK? not sure.
Thanks for re-affirmation.
Thanks for the update Fred. Good to hear from someone who has been actually investing on the platform for some time. There are certainly risks involved and their loan history is still very short that is for sure. They have a long way to go before they catch up to their English counterparts.
I am very impressed with their press release and social media volume
And by interest coverage Fred is probably meaning DSCR (Debt service coverage ratio). Banks usually go for 1.3 or so (business dependent)
Yes DSCR. I don’t know enough about small business lending to have a firm opinion about how high it “should” be for reasonable risk, and there is no data yet from FC loans which would give one any statistics, but from common sense I have decided that “less than 1” is too risky for me.
Yep. For the record banks really don’t do under 1.2 and I would question the underwriting.
Keep in mind that Funding Circle has been promising the fractional market since early last spring. They delivered this way behind schedule. I wonder if it was due to technical or legal reasons.
In my opinion, Funding Circle USA has generated way more hype than it deserves. If they hadn’t merged with Funding Circle UK they would be an also-ran in the P2P space.
My understanding is that they delays were to do with the regulatory environment but I have no details on exactly why.
I think it is a little unfair to call Funding Circle USA an also-ran in the p2p space. It is just that the small business lending space is a long way behind the consumer space when it comes to volume and development. But I am confident that over time FC USA will become a very successful company. Having said that I can certainly understand investors wanting to wait on the sidelines until FC and the small business marketplace lending space in general matures.
Thanks!