Unregulated asset-backed investments have been put under the spotlight following the failure of several mini-bond providers such as London Capital and Finance (LC&F).

While many mainstream funders are regulated by the Financial Conduct Authority (FCA), the mini-bond in itself is not. We highlight some areas of concern for more mainstream lenders such as banks who find themselves lending along side these products or otherwise involved in this space.

Securing your reputation

Banks have found themselves lending alongside mini-bond providers and, crucially, taking asset security ahead of mini-bond investors. These include casual investors or pensioners investing life savings hoping to get a generous return. But what happens when these products and the underlying entities fail, with the inevitable damaging headlines that follow?

Banks should ask whether the economic benefit of debt recovery is worth the reputational risk of standing ahead of such investors, many of whom are investing funds that cannot afford to be lost and stirring media interest that can be unhelpful to mainstream lenders.

The role of the ‘cheaper funding’ in the mini-bond provider business model

It has been well publicised that many mini-bond providers use marketing companies that can charge up to 25% to source new investors. This means that the funds available for investment are significantly behind from the beginning. The mini-bond provider, often having promised interest rates around 8%, requires a herculean return on investment just to break even - in some cases around 40-50%.

Chasing high returns inevitably puts pressure on mini-bond providers to access a lower cost of capital and many will be targeting banks for access to senior debt or project funding. This provides the credibility the market would expect and it is also essential to their business models.

The more that individual investments can be funded through cheaper sources of finance via banks, the longer the business can operate.

When the music stops

With mini-bond providers chasing sky-high returns, it raises the question of what the risk profile is of these investments. There is no doubt that many mini-bond providers operate in high risk assets, and when they collapse the waves they cause can be damaging and far reaching. Out-of-the-money secured lenders can then face lengthy enforcement, when such enforcement can be uneconomic.

As we have seen across several failures of mini-bond providers this year, it is only then that lenders and investors alike get a real look at the quality of investment activity undertaken or, in some cases, whether any investment activity was undertaken at all. By which time, any monetary and reputational damage has already been done.

Now is a good time to take stock and ensure that, as a lender in this space, you are fully aware of the risks in your portfolio. For more information and advice please contact Chris Laverty.

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