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What are the estimated bad debt rates, and how are they calculated?

Bad debt rates are defined as the “annual level of expected losses for a diversified investor”. The rates account for any funds not repaid by borrowers and not recovered from the debt collection process per year. Estimated bad debt rates are annualised so they can be used by investors to help work out what their expected annual return will be.  Diversified investors (defined as investors with no more than 1% of their portfolio lent to any one business) can calculate their expected annual return by simply deducting the bad debt rate from their gross interest rate they are offering to businesses.

Our experienced Funding Circle credit assessment team assess every loan application, and classify these into risk bands. Using data from Experian, including the historical amounts of bad debts experienced in similar businesses, and their professional expertise, our credit analytics team have made their best estimates of the likely levels of bad debt that will be experienced in each risk band. Current estimated bad debt rates can be seen below.

Remember, you are lending to businesses so your capital is at risk. 

Bad debt rates and fixed interest rates by risk band and loan term

Term A+ A B C D E
1-12 months 6.0% 9.0% 10.0% 11.3% 13.5% 17.4%
13-36 months 8.0% 9.2% 10.2% 11.6% 13.8% 17.7%
37-60 months 8.3% 9.5% 10.6% 11.9% 14.1% 18.1%
             
Est. annual bad debt rate 0.6% 1.5% 2.3% 3.3% 5.0% 8.0%

Whilst we apply a range of different factors to assess the estimated bad debt risk for a risk band, the main factors are as follows:Estimated bad debt rates should be considered across your portfolio of loans as a whole – they are not fixed for any individual loan but apply to the average across the group of loans within the risk band. Estimated bad debt rates are no guarantee of the actual bad debt you will experience for each risk band. Investors should spread their lending across lots of businesses to reduce the impact of any single default.  If you are using Autobid, it will not lend more than 1% of your total funds to any one business provided that you have £2,000 or more in your Funding Circle account (since the minimum bid amount is £20).

  • Probability of default (PD) – the likelihood a loan will go into default in its lifetime. The likelihood that a loan defaults changes over the course of the loan. For example a 36 month loan is on average more likely to default in month 24 than month 36.
  • Exposure at default (EAD) – the average amount of money outstanding at the point a loan defaults. As Funding Circle only offers fixed rate repayment loans the exposure at default can be calculated easily if the average time of default is known.
  • Loss given default (LGD) – the amount of money owed that is NOT recovered by our debt collection agency for defaulted loans. 
  • Probability of early repayment – the likelihood that a loan is repaid early.  This shortens the life of an average loan and therefore impacts on the factors listed above. Again, the likelihood of an early repayment changes over the course of the loan.
  • Exposure at early repayment – the average amount of money outstanding at the point of early repayment. As Funding Circle only offers fixed rate repayment loans the exposure at early repayment can be calculated easily if the average time of early repayment is known.

Funding Circle provides estimated bad debt rates for each risk band that apply to 6, 12, 36, 48 and 60 month loans. Analysis of bad debt rates by Funding Circle credit analytics team suggests that expected differences between annual bad debt rates by risk band for 6, 12, 36, 48 and 60 month loans are not statistically significant - in particular, when accounting for the prudent approximations and estimates used in the calculations.

Funding Circle will however continue to monitor and refine analysis over time and if, contrary to our expectations, significant differences emerge between bad debt rates by loan term, or indeed for any other factor, we will update our estimates and provide further detail to explain the changes.

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