Here are answers to the questions our investor community has asked about the Bondora Rating.
Why switch to Bondora Rating? Why is it good for me as an investor?
About Bondora Rating
Bondora Rating will introduce a fair risk-based pricing model to all the loans on the platform.
Until now loans have been classified not according to a risk model, but grouped together according to a similar payment problem history (600-1000) or discretionary income (A,B,C) of the borrowers. In other words, it does not allow to understand the risk level of a specific loan as it is merely a compilation of financial data, which may or may not be directly correlated with the risk-level of an investment.
Today’s pricing is based on the product, which is a representation of an average borrower with certain criteria. This means that 2 investors may get rather different default rates investing into very similarly looking loans in the same country. This also means that a low-risk borrower may get an overpriced loan and a high-risk customer can take a loan that’s underpriced.
Bondora Rating aims to show an expected loss (and an expected return) upfront and price the loans according to their respective risks. The expected loss and return are calculated based on historic data which, however, does not guarantee that future results will be the same as in the past. Our team will continue to maintain and develop the rating model to make it as accurate as possible.
When calculating Bondora Rating we source the following data:
- Our historical data on the customer, retrieved from loan applications;*
- External data, cross-referenced with other databases. The external data includes country of residence, credit history and data from public records;**
- Behavioral patterns, based on customer observations on our website.**
* Data publicly available to all investors through data export.
** Proprietary information, which cannot be shared.
Additionally, we use different criteria to predict expected loss in different countries and different contexts.
What Bondora Rating means for investors
We expect to see a similar average interest rate on the market as a whole, but Rating will provide a more predictable and risk-adjusted return. Bondora Rating will make the marketplace a fairer environment as higher-risk borrowers will be paying more, while lower-risk borrowers will be paying less.
If you are a passive investor, Bondora Rating will allow you to start building up your portfolio based on your desired risk level.
In time, we’ll be increasing the liquidity and usability of the Secondary Market also by applying Bondora Rating to each of the loans based on its performance and changes in the risk and returns. See ‘How will I be able to invest in the future?‘
How will Bondora Rating be rolled out?
Bondora Rating will be rolled out in 2 phases:
- With the next release Bondora Rating will be added to the Market pages for new issued loans. All loans that will have a negative return on investment according to the new rating, will be cancelled;
- Around Christmas, the new loan pricing and new Portfolio Managers will be implemented;
- In Q1 2015 we will start implementing Bondora Rating on the Secondary Market, including Secondary Market loans in Portfolio Managers and applying Bondora Rating to historical loan data.
With the new rating we expect to reduce proportion of the loans in the higher-risk segment, hence offer a better quality split of investment opportunities for investors. The price for higher-risk customers will increase due to a more accurate risk allocation per borrower. This will lead to a decline in accepted offers, as the rate will become too high to serve such customers. How will I be able to invest in the future?
There will be 4 possibilities to invest on the platform:
- Portfolio Managers – you can continue investing with the new Bondora Portfolio Managers, which will offer a possibility to select between preset or custom allocation of the risk grades;
- Portfolio Builders – enables you to save your investment criteria and apply the saved filters to find matching investment opportunities from the Primary Market. There will be more filters available in the future, but it is important to remember that if you are working with Portfolio Builder, you will only be able to invest into loans, which have not been funded immediately;
- API – if you are a tech-savvy investor, you will be able to build your own credit model and apply it to investing through the API solution;
- Secondary Market – with time will become available for investment through Portfolio Managers as well. Further development of Bondora Rating will define Secondary Market pricing, as the Rating for each loan will be updated over time depending on loans’ performance. Additionally, all loans put on sale on the Secondary Market will be priced according to a portfolio rating, not by investors. For example, a loan with a B rate might be re-priced to a higher or lower rate based on the borrower’s previous behavioral patterns on our marketplace.
How will Portfolio Managers be set up?
Old Portfolio Managers will work in parallel with the new Bondora Rating Portfolio Managers. You will not be able to use both at the same time and after switching to the new Portfolio Managers, your old ones will be stopped and archived (you would not be able to rerun them).
New Portfolio Managers will work exclusively with Bondora Rating and will have priority over the old ones. You will be able to choose how much you would like to invest in a single borrower, as well as define a desired amount of funds you wish to allocate per different Bondora rating class.
You will be able to continue using old Portfolio Managers if you choose to, but they will be locked for any edits.
Eventually loans should be released to the market after the auto-check but before a manual review. In case the manual review reveals a detail about the loan which would change its pricing, it will be returned to the market as a new loan. This means that in the future loans are likely to appear on the market 24/7, not only during working hours.
What data will I see about loans when investing using Portfolio Builder?
Data in Portfolio Builders will not change, but the credit groups (A / B / C) will be replaced with discretionary income.
Can I build my own credit scoring model?
Yes, you will be able to build your own credit score using the data export functionality, which we made available for you on our website. However, it only includes a publicly available fraction of the data, which we use when calculating Bondora Rating. A large share of key criteria in defining the risks come from proprietary data sources unavailable to investors.
You will be able to apply your credit range through a saved filter on Portfolio Builder or through the API. Will loans on the Secondary Market be scored and made available to invest through Portfolio Managers?
Eventually Bondora Rating will be applied to the loans on the Secondary Market in an adjustable format (meaning the rating will be adjusted based on the individual loan performance). At a later stage Secondary Market loans will also be made available for investment through Portfolio Managers.
How will interest rates be allocated in the new model grades? For example, how will the interest rate be allocated to Spaniards and Estonians in the same grade group?
Bondora Rating is defined by the Expected Loss Rate E(L), which is presented in the minimum-maximum range. If a borrower has a higher E(L) due to any country-specific or other risk factors, a lower Bondora Rating will be assigned.
When calculating LGD, EAD and PD figures for a specific loan application, any differences in country risks (such as recovery rate) are accounted for additionally to the macroeconomic systemic risks (such as sensitivity to economic crises). Estimated interest rates for borrowers in each grade group will be available on the new Portfolio Manager settings page:
How is it possible to have such a low expected loss rate as shown in AA group, when currently the default rates shown in the newsletter are higher?
Bondora Rating will allow for a much more accurate differentiation between lower- and higher-risk borrowers than the criteria previously used. In other words, in the EE A1000 Income & Expenses verified group, Loan1 could have an expected loss of 8%, Loan2 – 2%, Loan3 – 0.5% and Loan4 – 12%.
So far, it has been rather difficult to separate lower risk borrowers from the rest of the group simply by using Portfolio Manager criteria, as these are not always reliable factors for predicting the risk. Our new rating system will highlight the nuances between the risk levels of different loans, so the mentioned above loans would be assigned the following grades: Loan2 and Loan3 – AA grade, Loan1 – C grade, Loan4 – D grade. How reliable the score predictions will be? Are there any guarantees?
Bondora Rating has been developed based on the banking industry’s best practices and conforms to the industry standard. It has also been tested on our historical data. Additionally, we are going to continue improving it in the future based on the criteria influencing loan risks. See ‘Bondora Rating components‘.
However, Bondora is a mid-term investment product and as with any investment there is no guarantee on the returns. Bondora Rating distribution for the loans originated between January 2013 and October 2014 is presented in the graph below. Where interest rate and expected return figures are what they would have been based on the risk-based pricing.
It is, however, assumed that the share of high-risk (HR) loans will gradually decrease. See ‘Will the number of loans increase because of the new rating?‘
*rhs – right hand scale
Given that there is no external credit score in Slovakia (only payment defaults) and because there have only been very few loans on the market, the rating for these loans has been built using Estonian data as a proxy to back-test the ratings.
Does Bondora Rating include income tax rate in its calculations?
No, the calculations used in Bondora Ratings are based on the gross interest received. The income tax rate depends on the residency of the investor and a set of individual variables. We do not provide tax-related advice and would recommend to turn to a local tax advisor for additional information. As a general rule, investors lending through peer-to-peer platforms usually cannot offset loss against income.
How will the fraud and manipulation risk be minimized with the new Bondora rating system?
Large part of data, applied to calculate Bondora Rating, is not self-reported and is additionally cross-referenced with other databases. New rating will not replace anti-fraud measures, which will continue taking place and will be constantly improved.
How do the mentioned CAPM and Markit tie in and what it actually means for investors?
Minimum expected return is derived based on the capital asset pricing model (CAPM), as applied in the context of credit business. One single minimum expected return corresponds to each calculated loan beta in the same manner as expected return is a function of an asset’s beta in standard CAPM. Read more about CAPM on Investopedia.
Markit iBoxx Eurozone Retail ABS A EUR Index EUR has been selected as the market index. Risk free rate is assigned qualitatively, using various proxies such as Germany’s 3-Month Bond Yield, 3-Month Euribor rate and 3-Month EUR Libor interest rate as informational basis.
Loan beta is derived as the product of a loan’s risk parameters-based beta and the country beta.
The risk parameters-based beta is calculated based on a loan’s individual risk parameters, assuming an investor has a well-diversified portfolio. Specifically, Basel II IRB Risk Weight Function for ‘Other Retail’ exposure class is used as the basis for calculating possible unexpected loss. The calculated unexpected loss is then compared to the historical volatility of the selected market index.
Country beta accounts for the fact that different eurozone countries are likely to react differently to systemic risk events. It is estimated relative to the eurozone as a whole, meaning it is assumed that the euro area average beta equals 1.0. In the estimation process, past experience and future outlook of a country are equally weighted.
For an investor this means that at minimum, the expected return will cover reasonable cost of capital, taking into account the risks that an investor assumes when investing into a loan. Where is it possible to see the figures for ‘Markit iboxx Eurozone retail ABS index EUR’?
Markit iboxx Eurozone retail ABS index EUR can be found here.
(Navigation: Markit iBoxx Benchmark Indices -> Markit iBoxx ABS European -> Eurozone -> ABS exMBS -> Retail ABS -> Overall).
Registration is required to access this data.
What is the maturity factor applied to the loans shorter than 1 year?
Maturity factor M=1.0 applies to all loans with the duration of up to 1 year.
Maturity factor M=1.3 applies to all other loans.
Were cancelled loans excluded from a sampling model?
Cancelled loans and loans repaid before maturation were excluded from the sampling model.
What will happen to the statistics pages and data export? Will the old loans be re-evaluated?
Upon switching to Bondora Rating, all eligible loans will be re-evaluated and Bondora Rating will be displayed for informational purposes (it is important to remember that for historical loans Bondora Rating may not be very accurate due to incomplete data). All the loans, which would not be eligible for re-evaluation due to a considerable lack of data, will be labelled accordingly.
As soon as the re-evaluation process is complete, the statistics and data export pages will be updated. For some time during this process, however, these pages may be static and updated only periodically.