P2P lending hits a speed bump

The P2P lending sector is slowing, but it remains appealing in an era of zero interest rates, says David Stevenson.

Man walking away from base of human pyramid. © Alamy

The peer-to-peer sector is slowing, but it remains appealing in an era of zero interest rates

In our yield-starved world, peer-to-peer (P2P) lending once seemed like nirvana: lend to people via an online marketplace and receive income yields well above those on offer from savings accounts. Unfortunately, over the last year or so, the shine has come off the sector, although the numbers suggest that the overall P2P marketplace is still growing. Specialist website altfi.com (of which I am executive director) recently published a state-of-the-market report (available online after registration: altfi.com/state-of-the-market), which collates various industry data sources in Europe.

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A sharp slowdown in growth

The report shows that gross new lending in Britain topped £6bn for the first time in 2018, reaching £6.055bn according to specialist data provider Brismo. That represented a 20% increase on the previous year's total of £5bn, making the UK Europe's biggest online lending market a punchy rate of growth by most standards, but after two years of 40% year-on-year expansion, 20% represents a sharp slowdown. Brismo is forecasting another year of 20% growth in loan originations for 2019, which would lift the new annual figure to £7.27bn.

Look below the surface

But these big headline numbers on lending volumes don't tell us the whole story. A key segment of the P2P lending market is consumer lending, and according to the report growth is slowing down sharply loan volume growth was just 4.01% last year, with the rate predicted to drop to 3.8% in 2019.

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The slowdown is also apparent in property lending (comprising bridging loans, longer-term mortgages and development finance). Last year growth all but ground to a halt. This is due to several factors, not least the slowing residential housing market. But the trials and tribulations of lenders such as Lendy also remind us that lending standards have been astonishingly lax in much of the sector.

In the sector comprising loans to small and medium-sized enterprises (SMEs) dominant player Funding Circle has also run into trouble. The share price has slumped and returns on its listed SME lending fund have continued to disappoint. The fund is now being wound down after reporting unexpectedly high defaults from loans to small businesses.

This all points to one increasingly obvious problem: returns from investing in P2P lending have been declining. If you had deployed money on the largest platforms Zopa, RateSetter, Funding Circle and MarketInvoice you'd have earned a composite net annual return of about 4.1% in the first quarter of 2019, according to the Link Asset Services (LAS) Marketplace Lending Index published in March. This net figure, calculated after losses and fees, has been falling steadily for three years, from a recent high of 6.4% in the second quarter of 2016.

These low returns and increased defaults have started to spook some investors. Stephan Findlay, chief executive of BondMason, recently announced that his company would wind down its marketplace-lending activities owing to declining returns. Findlay suggests that net returns have shrunk by about 1% a year over the past two years for a mix of reasons including competitive pressure on headline rates for some types of lending, platforms' margin requirements, and rising loan losses.

Don't give up on the sector

Yet I wouldn't get too carried away with the pessimism. It's still possible to get returns of between 4% and 5% from the major consumer-lending platforms, and there is also solid evidence that these lenders have tightened up their borrowing criteria. Their growth rates in lending volumes have perhaps declined because they are no longer chasing unprofitable borrowers. What's more, that net return of just more than 4% from the asset class needs to be put in perspective. Assuming the average duration of the index's basket of P2P loans is about three and a half years, it's also possible to compare the P2P asset class' returns with more conventional fixed-income investments. P2P returns are well above the risk-free rate on three-year UK government bonds, which stands at less than 0.5%. P2P loans also provide a higher return than baskets of investment-grade sterling corporate bonds.

A yield-starved world

Money-market accounts are also mostly yielding less than 0.75%. As for high-street savings accounts, there are very few paying more than 2% and those that do usually require a one- to three-year lock-in although these savings accounts offer full protection from the Financial Services Compensation Scheme, which P2P investments don't.

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And as we enter into a brave new world of negative interest rates we'll see the scramble for yield intensify again. Currently investors in peer-to-peer lending benefit from a 2% to 3% premium in terms of income from investing in lending. The risk especially in consumer lending is that this premium might be entirely eaten away by defaults shooting up in a recession. However, that recession will also result in increased interest rates being charged by lending platforms, which in turn might result in a strong rebound for investor returns. The upshot? Despite its current travails, P2P's glory days may be ahead of it.

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