The illusion of buyback guarantees

If you have ever considered investing in unsecured, high-risk consumer or payday loans, you have probably come across terms like “Buyback Guarantee” or “Buyback Obligation” on the P2P consumer loans marketplace’s website.

A large number of European P2P lending marketplaces specializing in trading unsecured consumer debt obligations are advertising the buyback guarantee as a miracle tool that almost fully eliminates the investment risk and allows the investors to earn high returns without taking any risk. As with all miracles, the promise of a buyback guarantee should be treated as a marketing message and no serious investment decisions should be made based on that claim.

In short, the originator announces that all or part of its loans loaded off to the P2P investors via the P2P marketplace is subject to a buyback guarantee or buyback obligation. In most cases, the loan originator promises to buy back all the “guaranteed” loans that become 60 days late.

As there are no real third-party financial guarantees (as in the bank-issued first-demand guarantee), the loan originator is basically guaranteeing itself. Depending on the financial strength of the originator, the “buyback guarantee” might have some value, or it might just be an empty promise. The value of buyback guarantees depends on the creditworthiness of the loan originator. It is important to note, that all P2P marketplaces waive all potential liabilities arising from brokering those loan obligations having a “buyback guarantee”, so when shit hits the fan, you are probably on your own.

There are plenty of real-life examples where the originator’s buyback guarantee turned out to be worthless. The first publicly known failure is the Polish consumer and payday loan originator Eurocent S.A., which defaulted on their buyback guarantee obligations in 2017. Another good example is Aforti Finance SA, another Polish loan originator, which defaulted on its buyback guarantee obligations in 2019. What about Rapido Finance, Alexcredit, Kuetzal, Envestio, Monethera and other loan origination companies that have failed to repay their “guaranteed loans” borrowed via marketplaces?

What would Warren Buffet say?

Guarantees you can rely on

In terms of guarantees, there are just a few ones that would have some value in the event of the borrower’s default:

• First-demand bank guarantees or insurance bonds, that are issued by financially capable and professional financial institutions. Bank guarantees are quite common in the real estate industry, a good example would be either a performance bond ensuring the execution of construction works or a bank guarantee covering the warranty period.

• Mortgages on real estate assets, that are commonly used by real estate or mortgage loan crowdfunding platforms. As long as the total LTV (loan to value) remains in the reasonable range (usually not exceeding 70-80%) and assuming that the real estate appraisal report reflects the true value of the collateral asset, the risk of losing even the investment principal and accrued interest is quite low.

At Crowdestate, we believe in the full transparency of every project. We are always conducting thorough due diligence and disclosing the findings on each project that ends up being published on our real estate crowdfunding platform. None of our projects has had or will ever have a “buyback guarantee”.

Summary

• When going for the more secure investment product, pay attention to the availability and quality of the collateral. Always prefer mortgage-backed investments to the unsecured consumer loans.
• The “buyback guarantee” is a highly misleading marketing term that provides a false sense of security to the investors and has no whatsoever relationship with true financial guarantees like first demand bank guarantees;
• The “buyback guarantee” does not guarantee the principal or the interest of your investments, it merely passes the credit risk from the original borrower to the loan originator;
• The value of the “buyback guarantee” depends on the financial strength of the loan originator and its willingness and capability to honour its promises;
• When looking at the various rankings of P2P and alternative finance marketplaces, ignore the “buyback guarantee” criterion as it does not add any true value;
• The most important aspect of any investment or loan is its intrinsic capability to generate enough returns to pay back the principal and interest without a need to liquidate the collateral.

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