Over the years we have seen many issues arising from questionable practices adopted within the financial services industry – from individual mavericks, through to teams of people rigging the markets and even corporate irregularities.
In looking at Peer to Peer (P2P) lending, are we seeing another example of something that will become a high-profile embarrassment?
The Start of P2P
P2P started in earnest in 2005 in the USA where Zopa found a niche and expanded, funding both corporates and individuals. The market expanded and grew rapidly during the turbulent post-crash period of 2008. Loans made are now standing at billions of pounds and P2P lending is eating into the markets of traditional lender’s, such as banks. Additionally, the market for P2P lending has broadened from company loans to personal loans and mortgages.
The argument for their service is that their cost of administering a loan is reportedly substantially lower than for banks (2.7% as opposed to 7%). This allows them to offer more competitive products and offer faster turnaround from loan application to acceptance. The government supports such companies and has invested themselves to help small businesses.
Can P2P Survive?
There are concerns about the industry. If every major company operating in the sector is making a material loss, is that niche viable for businesses?
In their latest published accounts (2015/2016) many of the major P2P companies made substantial losses:
- Zopa Ltd – loss of £5.6m, assets of £13.6m
- Ratesetter (Retail Money Market Ltd) – loss of £4.9m, assets of £24.1m
- Funding Circle – loss of £37m, assets of £133m
- Landbay – loss of £2.1m, assets of £676K (prior to cash from share issue)
- Wellesley & Co Ltd (2014 accounts) – loss of £0.5m, asset deficit of 0.6m
It is not saying that these companies are going bust, but it raises the question as to when they will become insolvent if their business model does not change.
However, one of those in the mortgage sector fared more positively:
- Lendinvest – £1.998m profit, assets of £9.4m
Lord Turner, the FSA Chairman (2008-2013), initially took the stance that there should be major concern with this part of the Financial Services sector, but modified that view to saying that it will have a key role to play, providing it is properly regulated. The figures above show that there is cause for concern. These companies cannot continue to operate on the basis of raising capital from share issues, but must be sustainable from their own operations.
In the coming years there will be forces that will change the industry. It could be in the form of a major player going bankrupt, some sort of loan made for illegal purposes or simply changes in the economic climate. The ensuing publicity will require action from the P2P companies and well as from external bodies.
Currently, to attract investment to the P2P company interest rates of “up-to” 7% are being quoted. This compares to the minimal interests rates currently available from more secure investments. If interest rates start to increase the risk/reward calculation becomes less favourable to P2P companies. In fact, Lord Turner commented, “They [individual lenders] should only participate if they have money they can afford to lose”.
Loans made by P2P companies are subject to market forces and competition. If money is loaned to the P2P company they can only loan it out at a greater rate than they offer to the investor. If that rate becomes too high the P2P companies may find cheaper sources of money, such as the banks, and become more traditional in their approach. The other major pressure on lending will be competition from existing players, who may already have a less costly source of funds. They will not sit idly by and let business be taken without a fight.
P2P companies have historically had a low rate of bad-debts. Should a bad-debt occur the loss is usually suffered by the individual lender. However, some P2P companies are starting to ring-fence some cash for such instances so that the saver does not lose all their money.
It is clear that the industry will evolve. The key driver will be the economy. The wider economic landscape will drive the shape and business models of P2P companies in the future and determine the boundaries for money they can borrow and the rates at which they can lend.
The market sectors to which the P2P lend will also grow. The small-company loan is well established whilst the personal loan and mortgage sectors are now material. As entrepreneurs turn their minds to different areas, so companies will adapt to serve those markets.
The regulators will determine the level of funds P2P companies have available. If capital adequacy requirements, such as the Basel and Solvency series of regulation for the banks and pension companies, are imposed then the feasibility of such organisations to operate as they are may be called into question.
Currently the government sees P2P lending as a useful way to stimulate start-up and early growth businesses. From tax year 2016/7 P2P lending can be wrapped in ISAs, which further enhances the attractiveness of investing with them. This is likely to boost the funds under management. This positive approach to the sector could be undermined if there is adverse publicity, the consequences of which could be material cutting off a useful source of funds to young businesses.
The regulators will have to decide what needs regulating and how, without constraining the businesses who find such funding so attractive. If losses mount, then intervention will occur. But if the industry becomes stable (Zopa has been operating for more than 10 years), then the industry can grow unencumbered,
In summary, P2P investing and lending is part of the Financial Services market. It is here to stay and will morph over time based on external factors. The P2P companies will adapt and their offerings change as markets shift, whilst regulators and governments react to external events.
By KIS Finance