What has happened?
Polish lender Eurocent SA applied for a debt restructuring on Thursday 6th July. If this is unsuccesful, it stated that an insolvency and liquidation would take place. The lender joined the Mintos platform only 3 months ago. This is the biggest hiccup Mintos has had to deal with to date. Mintos is an exceptionally good P2P platform and they will be uncomfortable with these developments.
There are reports that Eurocent is seeking an extension, giving it a longer time repay lenders, but without a haircut to their claims. It is also seeking an investor. Trading in shares of Eurocent SA have been suspended after falling almost 90% in recent weeks. Shareholders will probably be wiped out.
Impact on Mintos investors in Eurocent loans
There may be zero impact from these events, if Eurocent successfully completes its restructuring, or finds a new investor to inject equity.
What happens if the company is declared insolvent? Eurocent will no doubt fail to honour its buyback guarantee commitments. However, investors will continue to own the rights to the principal and interest payments made on the loans they purchased from Eurocent. The other creditors of Eurocent should not get access to these cashflows (although it is possible there could be some legal wrangling over this point).
We expect that servicing of the loans will be transferred to another lending company, and the payments will be passed on to Mintos for distribution to investors. Transferring the servicing will likely be a last resort, as defaults tend to increase significantly when this happens.
What's the Plan B for Mintos investors?
If Eurocent ceases to operate, and Mintos transfers the servicing to another party, this leaves the question of what happens to the loans that default, and who will get the additional interest that is being generated on these loans vs the commitments to lenders.
We understand that two options are contemplated. The first option is to just give lenders the full amount of interest on the loans (less any collection expenses) and have them take losses on defaulted loans. This may not be a bad outcome for investors. The average interest rates on the loans are 90%, and Eurocent has reported a 30% annual default rate. The extra interest could potentially offset the losses.
A second option could be for Mintos to collect the excess interest, and use it to buyback loans that have defaulted. This would leave investors in the same position as if Eurocent had not failed. However we suspect that the mechanics of this would be very complex to implement. However, this may be the best option for Mintos from a PR perspective.
The financial disclosures from Eurocent have been poor
It is unclear is why Eurocent has run into trouble in the first place, as it should have been generating a 50% net return on its assets (90% interest, less 30% defaults and 10% funding cost). This suggests that recent performance may have been significantly worse than disclosed to investors. We have reviewed the financial disclosures made by Mintos and Eurocent to try and understand how Eurocent could have encountered such big difficulties within months of being invited onto the Mintos platform. We have noticed some inconsistencies and examples of inadequate disclosures when doing this:
- In an investor presentation on the Mintos website, Eurocent claim to have earned €11.6 million of revenue on assets of €5.9 million during the first 9 months of 2016. This implies that they generated an average yield of around 200% on their assets. This does not tally with the 81-107% APR Mintos says Eurocent charges customers. The size of the loan book is also significantly higher than the €2 million size reported by Mintos as at December 31.
- Mintos sent an email to investors on March 17 introducing investors to Eurocent. Many figures were provided, such as employee numbers and loans issued. The amount of equity in the company, and the profitability of the company, was not disclosed. It is unclear why the two most important figures for assessing the strength of a lender were omitted.
- The only financial statements provided are a blurry pdf file that is entirely in Polish.
- It was not disclosed to Mintos investors that the company had issued a public bond that was close to maturity, with no refinancing plan in place. Was Mintos unaware of this as a potential issue?
What can we learn from what has happened?
- This highlights how important it is to review the information available about lenders before buying their loans, particularly if a buyback guarantee is being relied on
- Tiny lenders can fall over very quickly without warning – Eurocent’s reported equity was less than €3 million at December 31
- It makes sense to allocate only a small amount of capital to small new lenders, and let them prove themselves over time before increasing their allocation
- Try and make sure that the financial information provided is recent, high quality and the numbers make sense
Update: 9th August 2017
What’s been happening?
Since this post was published on July 13 there have been a few developments:
- As predicted, Eurocent stopped honouring their buyback guarantee commitments. Buybacks were suspended on 21 July
- No progress has been announced by Eurocent on their restructuring efforts, although we understand that Eurocent is still working on one
- Mintos have taken the decision to allow Eurocent to continue to servicing the loans for now, but have appointed a backup servicer
- Mintos have requested Eurocent to distribute to them the extra spread on the loans that have not defaulted yet (i.e the difference between the 90% interest charged to borrowers and the ~10% paid to Mintos investors). We think it is unlikely that they will receive this prior to any announcements regarding a restructuring, or there is a court ruling
- Lenders who suffered a loss as a result of Eurocent failing to buyback defaulted loans will have an unsecured damages claim against the company. Mintos will have to seek a recovery for investors via liquidation of the company if the restructuring efforts fail. It’s unclear what recoveries there could be on these claims (we would imagine very low)
This creates some legal questions
We have been pressing Mintos to answer some legal questions about the situation, as we consider this a ‘test case’ for any other Mintos lenders who may become insolvent. Mintos have informed us that they have received a legal opinion “which confirmed that even in case the restructuring goes in the wrong direction, investors have the direct claim against the borrowers.”
Mintos also point to Clause 7.1.4 of the assignment agreement which allows them to take over the management of the claim, and in this event, “Mintos or, in case of transfer of the management of the Claim by Mintos to a third party, such third party shall be regarded as the Loan Originator as per this Agreement”. Therefore Mintos believes that it would be entitled to keep the interest spread normally retained by the Loan Originator, and pass this to investors.
Where does this leave mintos investors?
Mintos are having to choose between two bad options. The ‘do nothing’ approach, which creates losses for investors. Alternatively, take legal action and move the servicing to a third party. This approach has some costs, such as disruption to servicing, which can affect the amounts paid by borrowers, the cost of litigation, and the likelihood that it would destroy the chances of Eurocent obtaining new investment.
In the event that Mintos enforces the security, it plans to pool all of the extra spread, and honour the buyback guarantees with these funds. They plan to do this on a sequential basis (ie the loans that defaulted first will be bought back. It isn’t clear to us whether they will have the legal right to take this approach or apply the funds raised in this way. We suspect this could be very controversial.
We think a decision will be needed to be taken quite quickly. Every day that goes by, more of the loans default, and more excess spread goes to Eurocent rather than Mintos investors. While Eurocent were not a huge lender on Mintos, many will be watching this to understand what the downside case is when lenders on the platform fail.
Update: 23rd October 2017
Latest update from Mintos
Mintos recently provided a brief update on the situation. The key points we believe were:
- Since June the outstanding balance of Eurocent loans had fallen by 43%
- Between June and Sept 29 some of the loans qualifying for buyback had been partially bought back (it’s unclear which loans or what the methodology was)
- The court appointed supervisor had suspended any further buybacks since Sept 29
- Regular payments from Eurocent borrowers are being passed on to Mintos investors
We are not surprised that the court has suspended the buybacks and were actually surprised that any of the buyback liabilities had been fulfilled since it went to the courts to seek protection in July. We have very strong doubts that Eurocent is likely to remain in business. Financial companies need to be restructured within days rather than months, otherwise their business is usually too damaged to continue. It seems more likely to us now that the portfolio will be run-off, and that Mintos investors are at risk of a loss on the non-performing loans. We hope we are wrong, but we see little chance that someone will now buy Eurocent. The Eurocent loans have high interest rates, and the difference between the interest rate received and paid to Mintos investors is now effectively being shared with all creditors. Unless Eurocent finds a new investor quickly, we think it would make sense for Mintos to take over the collections and pay the interest spread to investors who have suffered losses from failed buybacks.