- Bernard Kellerman - Chartered Accountants Australia and New Zealand
Peer-to-peer lending is an increasingly popular form of investment/financing, but the sector is in a state of flux.
History is repeating itself in a post-GFC world, where interest rates for investors are low and the cost of finance in several key areas is high.
It’s this arbitrage that peer-to-peer lending has sought to exploit – and has tried for a decade.
Zopa is the world’s oldest peer-to-peer lending service, and Europe’s largest. It came out of a post-dotcom background, emerging in the UK in 2005 as an internet-enabled business that was able to make money for its founders by matching borrowers with lenders, and taking fees for doing so.
After going into near hibernation and closing down offshore operations as a result of the global financial crisis, when too many loans went sour, the UK lender is making a comeback – but this time it’s different. There are many versions of the Zopa model – all variations on more the formal form of the one-to-many aspects of crowdfunding.
Now, the sector is expanding rapidly, but is in a state of flux. The involvement of lenders, what regulations should apply and the scale needed to ensure sustainable business for the longer term are all still very much up for debate.
“Peer-to-peer (P2P) lending is doing for finance what Airbnb has done for shaking up the accommodation sector,” says Matthew Powell CA, chief financial officer of UK start-up Lending Works.
“It has put people in touch without the middleman, or at least got the middleman to take a step back and give everyone else a fairer deal.”
Others are keen to agree.
“The personal loan sector is the next space that needs disruption and disintermediation,” says Stephen Porges, a self-described serial entrepreneur in Australia.
He is now executive chairman of revitalised and recapitalised lender, DirectMoney, which is moving towards a reverse IPO on the Australian Securities Exchange to raise much needed capital – a sign of how some see the rapid expansion of this sector playing out.
“We saw it in the mortgage market,” says Porges, harking back to a previous role as chief executive of Aussie Home Loans, which used securitisation in the 1990s to raise cheap funding and drive down home loan rates in Australia, stealing market share from the big banks along the way.
According to Porges, 3% of Australian banks’ assets are in personal loans but 17% of their earnings come from that space.
He says this gives him and his fellow entrepreneurs plenty of margin to play with, and that will be the situation for some time to come – depositors are being paid around 2% and prime personal borrowers might pay 14%.
“Now, that gap is obscene,” he says. “It’s time that gap is closed in the personal space.”
Porges adds that the old peer-to-peer model, where individual borrowers and individual lenders had exposure to each other, is past.
“We think there needs to be a pooling of risk. So, it’s marketplace lending, it’s not peer-to-peer, as it’s not one individual lending to another. It’s very much borrowing from a pool and lending into a pool.”
It’s also how these newcomers manage risk-adjusted returns that give rise to claims of having the edge over banks and other traditional lenders.
And one of the newest of the new kids on the block in the UK market is Lending Works. Powell says that the rise of lending platforms has been shadowed by the increasing adoption and acceptance of comprehensive credit reporting, which allows smaller investors – “the everyday person in the street” who may have in the past parked some of their spare cash in a term deposit – to look at alternative investments with more confidence.
He’s also keen to point out that the financial regulator in the UK, the FCA, does not allow peer-to-peer lenders to compare themselves to bank deposits due to the very different risk profiles. That is left to the platform operators, like him, and to individual investors to decide.
“We’ve spent a lot of time with credit reference agencies building a scorecard,” says Powell, a former assurance professional at EY in London.
“We look at affordability, we’ve got links with the fraud prevention agencies and we also have further checks on bank account details. We’ve also got income verification checks.
“The final check we do before we pay the funds is whether the customer owns that bank account because that’s a key risk of fraud.”
Risk management for lenders has been taken a step further by Lending Works as a selling point, with Powell taking a year to negotiate insurance coverage for loans where the borrower can’t pay or where lenders are hit by fraud or cybercrime, as well as setting up a provision fund to cover loan defaults that can’t be paid out by insurance policies.
Another approach to matching borrowers and lenders, while managing risk, is that taken by Lending Club, by far the biggest P2P business anywhere.
On its website, Lending Club claims to have issued US$7.6b in loans to the end of 2014, with more than US$1.4b in the last quarter.
The company pays a lot of attention to matching intending borrowers’ profiles with investors’ risk appetites. Loans are assigned a grade (from A to G) based on the credit quality and underlying risk of the borrower.
Nevertheless, Lending Club can be thought of more accurately as a partnership between a technology company with loan servicing expertise and a bank, sitting between borrowers and investors in order to clip a variety of tickets on the way through.
Lending Club earns transaction fees on loans issued by WebBank, an FDIC-insured bank with a Utah state charter. WebBank pays Lending Club for technology that applies proprietary risk algorithms, based on the issuing bank’s underwriting guidelines, to originate loans and assess loan applicants.
Each investor, in effect, buys a specific share of a specific loan from Lending Club, which is how it distinguishes its funding process from securitisation deals.
Lending Club also earns a recurring servicing or management fee of about 1% from its investors for the subsequent servicing of loans.
Harmoney for borrowers
In New Zealand, the marketplace lending landscape is already being dominated by Harmoney, launched in September last year with NZ$100m to lend and backed by the local Heartland Bank and New York based Blue Elephant Capital Management.
Harmoney recently raised a further NZ$10m, from Heartland and online business Trade Me, for business expansion into new markets and possibly new loans – mortgages in particular, which Roberts sees as the natural extension of consumer lending.
As of April this year, Harmoney had lent almost NZ$50 million, according to its founder Neil Roberts. He says loans are averaging NZ$14,000 to NZ$15,000. This puts it well ahead of any likely competition across the ditch in Australia, where the regulatory landscape is far less certain than in NZ or Britain.
Nevertheless, Roberts is planning to set up shop in Australia in the near future.
Australia still in shadow
P2P lenders in Australia have to deal with a high level of regulatory uncertainty – a point that was underlined at the Australian Securities and Investments Commission annual summit in March this year, where there was plenty of discussion about the appropriate degree of regulation of innovative financial models.
ASIC commissioner Greg Tanzer said regulation of the sector may vary according to whether a new service was driven by consumer demand or by arbitrage opportunities facilitated by technology.
Also speaking at the same ASIC forum was Matt Symons, chief executive of the peer-to-peer lender SocietyOne, who suggested that although the new business models may be performing similar functions to traditional banking, the prudential risks could be very different.
Symons said: “Should we have to hold regulatory capital? We argue that P2P lending is fundamentally different because there is no asset-liability mismatch, as there is in traditional banking where intermediaries borrow short and lend long.
“In our model, investors sign up for the term of the loan. It is a perfect duration match.”
Another entrant into Australia’s P2P lending market, MoneyPlace, started trading in the June quarter this year, joining others such as SocietyOne, RateSetter, DirectMoney and ThinCats.
MoneyPlace chief executive Stuart Stoyan says there is room for more than two or three players in the market. He estimates that total Australian P2P lending to date as around A$20m-25m, with SocietyOne accounting for A15m-$20 million, RateSetter accounting for A$2m and ThinCats A$1m.
While many P2P operators are focusing on the mass market (consumers needing car loans, weddings, medical costs) few have moved on a more obvious area – a pure play for small business lending.
In the Australian market, as has been done in the UK arena, lending to small business been taken on by ThinCats Australia, a joint venture set up in December 2014 between local investors and ThinCats UK, an establihsed specialist lender to small business.
ThinCats UK was established in 2011 and has loaned about £100 million. Borrowers must apply through a “sponsor” – a licensed finance broker – who vets the applicants and helps them prepare their documentation. The funds come from sophisticated lenders with the expertise to understand business risks such as cash flow, inventory management and industry sectors.
The UK default rate is about 2%, and loans in default are passed over to debt collectors.