When Zopa launched as the UK’s first peer-to-peer lender in 2004 the sceptics could be forgiven for believing it would be killed off by competition from the banks. But, more than a decade and one financial crash later, the British marketplace-lending industry was worth €4.4 billion in 2015 and the question now is not whether it will survive but what shape it will take.
A huge number of platforms have formed to answer the needs of borrowers looking to alternative sources of capital. With banks still retrenching after the global financial crisis and small and medium-sized enterprises starved of much-needed finance, 2016 may prove to be a milestone in the history of the sector.
While it has traditionally attracted retail investors, institutional investors are beginning to take notice as more and more MPLs show a decent track record of returns. The sector’s future appears secure, but questions still remain.
Chris Philp, a Conservative MP and member of the UK government’s Treasury Select Committee, has been vocal about the need for MPLs to co-invest alongside those putting capital into their funds. The demand goes to the heart of the MPL model, where platforms earn revenues from the fees generated by connecting borrowers and investors. Interest on the loans are paid to the investors, who can expect returns of around 6-7 percent.
Philp thinks there is a misalignment of interests when MPLs are not putting in their own capital alongside that of their investors.
“When there is no participation or skin in the game from the MPLs in their loans, then there is no incentive to look at the credit quality of the borrowers. Co-partnering is critical to the industry as it aligns the interest of the MPL with its investors,” he says.
Philp recommends MPLs put up 10 percent of the total capital when providing a loan to a borrower as a way of protecting unknowing retail investors exposing themselves to low credit quality borrowers.
The Financial Conduct Authority undertook a review of the industry over the summer, consulting a number of stakeholders, and is expected to publish the results in the near future. For Philp, a balance sheet risk requirement is something he would like to see emerge from the study. “The FCA has applied a light-touch approach to the sector as a way of encouraging it to develop, but I’m concerned that any regulatory oversight will be too late, leading to a repetition of the mistakes from the past,” he says.
It’s an issue on which the industry is split. LendInvest, a real estate property MPL, says that it already takes risks on its own balance sheet and is pleased to see that its model chimes with Philp’s proposal. “We pre-fund loans before making them available to our online platform for investors to invest in. This is a form of skin in the game that has worked well for us and our customers for a number of years now,” says a spokeswoman.
Samir Desai, chief executive of Funding Circle, disagrees. He’s worried that it if such a proposal were introduced, it would hand an advantage to the banks.
“Platforms do not hold inventory, which allows them to efficiently connect investors looking for yield with small businesses requiring capital,” he says.
“Forcing platforms to hold 10 percent of the loans would put them at an unfair disadvantage to banks which invest minimal equity in their own loans and seek to curtail the sector’s growth, or create a regulatory arbitrage with direct lending funds and asset managers which are not required to invest their own funds in loans they make.”
A MATURING MARKET
For Philp, it’s important that retail investors be protected from taking on risk that they are not prepared for – a natural concern for a nascent market.
But as the industry grows more sophisticated, it is becoming easier for investors to discern between the experienced players and those unable to deliver promised returns. The UK also benefits from having the largest MPL sector in Europe and was among the first to introduce regulation of the market.
The European Commission has signalled its support for the MPL model. Under the Capital Markets Union plan, the EC sees MPLs as an important source of financing for SMEs and is keen to encourage the further development of the market. Such a view has been reflected in the European Investment Bank’s €100 million investment in Funding Circle – its first capital commitment to an MPL – in June.
Khalid Naqib, senior investment officer at the EIB, says the attraction of Funding Circle was that it was one of the most established players in the market. “Our goal is to have an impact on SME lending and provide liquidity where it is needed. The development of alternative channels of financing for SMEs is a key pillar of the plan,” says Naqib. He hopes that the investment will serve as an endorsement of the business model.
Australian bank Macquarie has also opted to work with an MPL and in April provided a £40 million (worth $58 million; €50 million at the time) senior debt warehouse facility to LendInvest. The line of credit enables the MPL to source its own opportunities and provide bridging and buy-to-let loans in UK property markets. It was the firm’s solid track record of lending in the industry that attracted Macquarie’s commitment, says Christian Faes, chief executive of LendInvest.
“Institutional investors, such as Macquarie, do a huge amount of due diligence before undertaking a transaction. We’re introducing investors to a new asset class and in the next five years aim to diversify our capital base and attract more institutional capital,” he says. Gianfranco Simionato, head of fixed income EMEA at Macquarie, explained the decision to invest in the property lender. “It is a space that high street banks find difficult to compete in,” he says. “We look to partner with a team with the right fundamentals. LendInvest has strong credit experience and is able to underwrite property loans in an efficient way.”
JOINING THE POOL
In an attempt to scale up and attract institutional investors, MPLs have been pooling their assets into a single security, a strategy pursued by some in the US. This year, Funding Circle started the trend by embarking on the first securitisation of MPL loans, valued at £130 million.
Securitisation enables Funding Circle to issue bonds against the assets, separating them into tranches based on the riskiness of the borrower. As a result, institutional investors can buy whatever tranches fit their risk strategy.
Michael Lorraine, partner at law firm Simmons and Simmons who worked on structuring the security, says: “Ordinarily, these are retail investors providing capital to [MPLs]. Increasingly, institutional investors are lending to these platforms, but they do not want to be 100 percent exposed to unsecured SME loans.
“Securitisation is useful, because it effectively tranches the risks of the underlying assets and enables the MPL to issue bonds to institutional investors. Losses are absorbed by those holding the riskier notes first.”
While securitisation offers one path for MPLs to tap into institutional investors, regulations that arose out of the global financial crisis combined with the stigma of the instrument can act as a deterrent. Nevertheless, Zopa, which lends against vehicles, embarked on a similar process in September, pooling a number of loans the platform had originated. It was granted an AA- rating from Fitch and Aa3 rating from Moody’s on the most senior tranches.
For Zopa chief executive Jaidev Janardana, the ratings “validate the robustness of our platform” and “expand the universe of people who can participate in peer-to-peer lending”.
First the trickle, soon the waterfall, is Moody’s observation on the securitisation of MPL loans. According to its report into securitisation across the fintech sector, more MPLs will “tap financial markets for their growth strategy, liquidity and for more stable funding”. It adds that while banks will remain the first stop for any consumer or SME borrower, the growth of the MPL sector and its ability to achieve high margins means it has an exciting future.
In May, financial services firm Deloitte asked if the MPL is a temporary phenomenon. The answer was a clear no, but the mainstream lending activities of the top banks had little to fear. Instead, Deloitte saw a future based on partnering with banks – a growing trend on the other side of the Atlantic, where the market dwarfs the UK sector (MPL-originated loans in the US were worth $23 billion in 2015, according to Deloitte).
Many expect the total value of MPL-originated loans in the UK to increase this year, despite fears over increasing risk in the sector and the potential for stricter regulations. The troubles surrounding Lending Club, while not necessarily exposing problems inherent to the MPL business model, have also created a negative perception among some outside the industry.
A huge number of players have entered the market pursuing increasingly niche strategies. Cars, unpaid invoices and various personal assets can all be held up as collateral by borrowers seeking liquidity.
Observers now anticipate a period of consolidation, purging the weaker players and entrenching the strongest. What the future of the market looks like is unclear, but the consensus is that it’s here to stay.