The demise of Lendy, and why P2P can’t reinvent the basics of finance
If you are offered a temptingly high return on anything, says Merryn Somerset Webb, it is because it is illiquid and risky. That’s something that investors in peer-to-peer platform Lendy should have realised.
If you can't get a good return from a bank account and you are British what's the next best thing?
It is, obviously, a good-looking return from anything backed by property, the thing we Brits collectively believe to be the safest asset in the world. That's something the founders of bust peer-to-peer lender Lendy clearly understood.
Lendy's marketing material explained the brilliance of the concept which matched retail investors looking to make more than the usual 1% on their cash with property developers apparently willing to give it to them.
This was great for the developers. Where banks might take months to decide whether to lend them money, Lendy's marketing material said it could do it in a "matter of days". It could also lend against projects that the "banks would be unable to value confidently". And it could lend in volume retail investors were so keen to lend, said the firm, that loans were "often oversubscribed by ten times".
The returns sounded so tempting
It sounded just as good for investors. They got the peaceful, easy feeling of knowing their loan was secured against UK property, and that there was a "four step due diligence process...often done to a higher quality than at major banks" as well as a "five phase credit assessment" to back the whole thing up.
But best of all, the loans promised returns of up to 12% "one of the highest interest rates of any peer to peer platform". This, said Lendy, made them perfect for low-risk diversification.
In a marketing email from early 2018, the firm suggested that "investors who include peer-to-peer (P2P) investment in their otherwise all-cash portfolios can substantially increase overall returns, with only limited downside". It compared investing all of your money in a cash Isa to putting 90% in cash and 10% with Lendy.
If your cash Isa paid 2% interest and 10% of your P2P loans defaulted, you would still be up on the deal. If an almost unthinkable 20% defaulted, you would be mildly down (your return over the two years would be 3.9% rather than 4%). For a cautious investor, this level of risk feels low.
Later in 2018, another marketing email from Lendy took this "it's a bit like a bank deposit" idea even further. Why not lock your money up in a new "wealth product" with Lendy for 60 days and you could earn yourself 6%? Make it a year, and that return would be 10%.
It sounded too good to be true and it was. Lendy went into administration in May. You can read the details of its miserable demise at lendy.co.uk.
It all started so well for Lendy
In the early days, Lendy (then called Saving Stream) started out with a reasonable idea offering 12-month bridging loans on existing properties when there was a genuine gap in the market. However, in 2016 it expanded into lending to property developers. This, noted administrators RSM in a report this week, was a "fundamentally different proposition...with a more complex and higher risk profile".
Why? For one, the timeline is longer developers draw down cash from lenders in stages. You also can't really value an ongoing development, or be sure how much time and cost overruns are going to change the numbers.
By late 2017, Lendy's non-performing loan (NPL) rate had started to rise. Investor confidence was falling, and so was the rate of new money coming in. That meant that Lendy was unable fully to finance the development loans it had already committed to. Developers who had agreed to borrow money were then unable to keep building, thus the number of expensive disputes and NPLs rose again.
This nasty spiral continued into 2018. Although Lendy's marketing attempted to reassure investors that there was a "strong pipeline of repayments scheduled", cash stopped coming in.
By January, Lendy was under the financial regulator's supervision (rather too late in the opinion of most people) and by May it was all over. The administrators reckon they can recover less than 60p in the pound on the loans. But chuck in the costs of doing so (RSM hires out its partners at £625 an hour) and most investors will be lucky to see any of their capital back let alone the promised 12% return on investment.
This sorry tale involves digital platforms, and the whizzy sounding innovative finance Isa (IF Isa). Yet the demise of Lendy is a new take on an old story one of mispriced risk, misleading marketing and complacent regulation.
Lendy expanded into a business area it wasn't very good at. As John Cronin of Goodbody Stockbrokers notes, it is "hard to see how an infant could underperform Lendy's underwriting decisions" given that administrators have found "35 of Lendy's 54 corporate borrowers have gone bust." So much for four-stage this and five-stage that. Perhaps there was a reason why the banks couldn't value this stuff "confidently".
Lendy also massively underplayed the risks of its business (yes, property does come with risk). The cash Isa comparison makes no mention of what happens if 40% plus of the loans default (as they have done). The P2P platform also presented something illiquid property that hasn't been built yet as reasonably liquid (the 60-day "wealth product").
Investors must take some of the blame for their misfortunes
But investors are culpable too. If it were really possible to get anything close to 12% without taking massive risk, it wouldn't be retail investors who got the returns. It would be institutional investors all of whom are mad for yield and keen to take more risk than they should to get it.
Yet when Lendy tried to get institutional investors on board in 2017, they weren't having it. They could see the pyramid-style risks in constantly needing new money to come in to meet old obligations and that if you looked at the real risks, a 12% return wasn't nearly enough.
In an age in which there is almost endless institutional and, in particular, private-equity money looking for a home, most things left on the table for the retail investor should probably stay on the table.
Remember the old joke about the $10 bill on the sidewalk? Economists don't bother to pick it up on the basis that it can't possibly exist. Any $10 actually there would have been picked up already. It's the same with the almost-no-risk 12%. It can't really exist if it did, someone else would have it already.
The key point is this: if you are being offered a temptingly high return on anything, it definitely is both illiquid and risky. That's the way it has always been, and it is the way it will always be. No new structure can reinvent the basics of finance.
This article was first published in the Financial Times