Diversity key to P2P lending success

Peer2Peer lenders (P2P), online platforms that connect borrowers with lenders, need to ensure they have a diverse range of institutional investors and permanent capital if the model is to flourish.

As an asset class, P2P is capitalising on the lending gap left by banks due to their balance sheet capital pressures under Basel III. PricewaterhouseCoopers (PwC) estimated that the P2P market could grow to up to $150 billion by 2025, up from $5.5 billion in 2014. Even traditional investment banks such as Goldman Sachs which have steered clear of retail are looking to launch online loan businesses.

P2P lenders are establishing their own investment trusts as a means to raise permanent capital. Funding Circle, the largest UK P2P lender, raised £150 million from institutional investors when it listed the Funding Circle SME (Small to Medium Sized Enterprise) Income fund on the London Stock Exchange in November 2015. This came after P2P Global Investment’s investment trust raised £250 million in an over-subscribed C-share issue. This permanent capital has enabled P2P lenders to invest and grow their businesses.

Mark James, managing director at Jefferies, speaking at the London Stock Exchange’s Investment Fund Conference, said P2P lenders needed to ensure that they have a diverse range of investors. He added a number of private banks were assessing whether to invest into P2P enterprises. Many investors find the P2P business model appealing. Zero or negative interest rates are forcing investors to chase yield, and this can be attained through P2P lenders.

Nonetheless, there are concerns around a lack of investor understanding about the asset class. “P2P lending is a very exciting asset class. However, I exercise some caution around it and the main reason for that is because the asset class has yet to witness a full economic cycle,” commented John Newlands, head of investment companies’ research at Brewin Dolphin.

The asset class is facing scrutiny. Some investors are acquiring loan tranches from P2P lenders as a mechanism to generate a fixed income. These tranches often come in the form of securitisations, which has caused some concern given the parallels with sub-prime mortgages and collateralised debt obligations (CDO).

Lord Adair Turner, former chairman of the then UK Financial Services Authority (FSA) warned that the growth of P2P could result in significant losses. Lord Turner warned these losses over the next five to ten years “would make even the worst bankers look like absolute geniuses.” He added P2P lenders issued loans quickly – often at lower interest than banks - and questioned the veracity of their credit checks. If markets were to sour, there are fears borrowers could default leading to lenders nursing losses.

P2P lenders highlighted they conduct thorough credit risk assessments and operational due diligence on borrowers, a point made by Simon Champ, chief executive officer at Eaglewood Europe, P2P Global Investments. “P2P lenders will employ highly experienced credit experts,” said Champ. Nonetheless, there is a strong possibility greater regulation of P2P lenders will be forthcoming.

The P2P market is larger in the US. Lending Club, one of the biggest P2P lenders, went public in December 2014. A paper by Morgan Stanley said marketplace loan origination had doubled every year since 2010, and stood at $12 billion in 2014. The Peer-to-Peer Finance Association (P2PFA), a UK body, said P2P lenders lent out £2.2 billion in 2015. The sector has now lent £4.4 billion in total, added P2PFA, and is now double the size of what it was in 2014.

Service providers have been urged to recognise this growth. Dr Christopher Sier, co-lead at Finexus, speaking at the Global Custody Forum in London in December 2015, said global custodians had failed to recognise the growth potential of P2P lenders and urged them to engage more in the space.