Addressing P2P lending’s wafer-thin margins

Putting mon­ey into the peer-to-peer, or P2P, lend­ing sec­tor once seemed like a no-brain­er. The orig­i­nal com­pa­nies in the sec­tor, includ­ing Zopa, care­ful­ly vet­ted their bor­row­ers, only lent to a tiny pro­por­tion of those who asked for cred­it and churned out reli­able returns of 4 to 6 per cent, year after year, for their investors.

On top of that, the sec­tor, in which com­pa­nies match bor­row­ers with third-par­ty fun­ders, offered a feel-good fac­tor: the chance to help the econ­o­my while help­ing dis­rupt the dis­graced bank­ing sec­tor out of its some­times shab­by ways.

I pre­dict fur­ther spec­tac­u­lar crash­es, even among the larg­er play­ers, unless bet­ter reg­u­la­tion comes in

Since Zopa became the UK’s first such lender to be launched in March 2005, Britain has become one of the world’s most advanced mar­kets for P2P lend­ing. UK com­pa­nies lent £6.7 bil­lion over the past 12 months, £1 bil­lion more than the rest of Europe com­bined, accord­ing to data firm Bris­mo. The government’s intro­duc­tion of inno­v­a­tive finance ISAs in April 2016 fur­ther fuelled growth.

How­ev­er, in recent months the rep­u­ta­tion P2P lend­ing, also called mar­ket­place lend­ing, has soured.

Ramifications of P2P for the UK

In Feb­ru­ary 2018, the Man­ches­ter-based plat­form Col­lat­er­al went bust after being caught trad­ing with­out a licence. In May, the prop­er­ty lender Lendy col­lapsed into admin­is­tra­tion with more than half of its £160-mil­lion loan book in default. Then, on July 2, shares in stock mar­ket-list­ed Fund­ing Cir­cle, which has lent £7 bil­lion to busi­ness­es since its August 2010 launch, crashed after it halved its rev­enue fore­casts.

Experts are pre­dict­ing that a fur­ther 12 P2P lend­ing plat­forms will col­lapse over the next year. “I pre­dict fur­ther spec­tac­u­lar crash­es, even among the larg­er play­ers, unless bet­ter reg­u­la­tion comes in,” says Roger Gewolb, co-founder of Fair­Money and the Cam­paign for Fair Finance.

And the sec­tor faces struc­tur­al issues. The mar­gins avail­able to plat­form oper­a­tors are wafer thin, some plat­forms have had to low­er their cred­it stan­dards, inter­est rates will inevitably rise from their cur­rent lows and the sec­tor has not yet had to con­tend with a down­turn.

How­ev­er, Iain Niblock, co-founder and chief exec­u­tive of the aggre­ga­tion plat­form Orca Mon­ey, believes investors would be extreme­ly fool­ish to write off an entire sec­tor because of the recent col­laps­es. He points out that nobody is dis­miss­ing the entire col­lec­tive invest­ment fund sec­tor as a no-go area, just because Neil Woodford’s flag­ship fund has been sus­pend­ed.

Mr Niblock says: “I think peer-to-peer lend­ing has a place in every retail investor’s port­fo­lio. Over a large num­ber of years, the returns have been steady and they have been uncor­re­lat­ed to the stock mar­ket, giv­ing peo­ple a valu­able diver­si­fi­ca­tion ben­e­fit.”

FCA new plans to further dent P2P

Estab­lished plat­forms, such as Lend­ingCrowd, Lend­ing Works, Rate­Set­ter and Zopa, are still deliv­er­ing annu­al returns of 4 to 6 per cent a year. Though this is down on 2016 lev­els, it is high­er than any bank sav­ings account, though there is clear­ly greater risk. “Nowhere else per­mits such attrac­tive returns for short-term cash deposits,” says Mr Gewolb.

Neil Faulkn­er co-founder and chief exec­u­tive of 4thWay, which rates P2P lenders, says: “As long as investors stick to plat­forms that over­whelm you with lots of clear infor­ma­tion and sta­tis­tics on their results and all aspects of their busi­ness, and as long as the investor spreads their mon­ey across a bas­ket of plat­forms, there’s no rea­son to wor­ry.

“It was inevitable that default rates would start to rise, giv­en we’ve been going through a rel­a­tive­ly benign peri­od for so long. If they have gone up from 1 to 2 per cent that may be a dou­bling, but it’s still low.”

The clam­p­down that the Finan­cial Con­duct Author­i­ty (FCA) unveiled in June, which was not a response to Lendy’s col­lapse, but fol­lowed a two-year review of the sec­tor by the reg­u­la­tor, may fur­ther dent the P2P market’s for­tunes.

From Decem­ber, the reg­u­la­tor will lim­it the amount any indi­vid­ual investor can put into the sec­tor to 10 per cent of their investible assets, unless they have received finan­cial advice. The reg­u­la­tor will also require plat­forms to strength­en their gov­er­nance and cred­it under­writ­ing stan­dards, improve their trans­paren­cy and rein in their mar­ket­ing.

Underestimating the danger of P2P

Mr Gewolb does not believe these changes go far enough. He says it is absurd for reg­u­la­tors to treat peo­ple who lend mon­ey through a P2P plat­form as investors. They should, in his view, be treat­ed as depos­i­tors and cov­ered by the UK’s Finan­cial Ser­vices Com­pen­sa­tion Scheme, which cov­ers £85,000 of sav­ings per indi­vid­ual, per insti­tu­tion.

“These firms are a still going to be reg­u­lat­ed as if their cus­tomers are investors, not depos­i­tors, and nobody is real­ly inspect­ing the books. The cow­boys have been left in charge of the ranch,” he says.

Adam Bunch, co-founder of the Lendy Action Group, which rep­re­sents investors affect­ed by Lendy’s demise, says the FCA’s new rules come five years too late. He believes the FCA had been caught on the hop by a new sec­tor which it had allowed to grow “vir­tu­al­ly unchecked” and with “bare­ly any reg­u­la­tion”.

So if investors are get­ting cold feet, where else should they look for P2P-like returns? Mr Niblock thinks buy-to-let prop­er­ties are the clos­est match. But David Pen­ney, direc­tor of char­tered finan­cial plan­ners PR&W, says: “The best alter­na­tive would be a bal­anced port­fo­lio of pre­dom­i­nant­ly equi­ties and bonds, pro­vid­ed they have the right risk pro­file and a suf­fi­cient time hori­zon to take risk.

“P2P may have a place, in spe­cif­ic cir­cum­stances, for investors who can afford to lose their cap­i­tal. In my expe­ri­ence, peo­ple often under­es­ti­mate or mis­un­der­stand the risk. They see the ‘inter­est’ in a P2P loan as akin to inter­est on a cash deposit. They’re com­par­ing 4 per cent inter­est on P2P against 1 per cent inter­est on a cash ISA, with­out recog­nis­ing the risk of the loss of cap­i­tal.”