P2P lending sector’s growth put on pause

The news last week that RateSetter has been sold to challenger high-street bank Metro is yet more confirmation that the peer-to-peer (P2P) investment revolution has been delayed, if not cancelled. Metro, which has its own challenges, has agreed to pay £2.5m, with an additional £0.5m after 12 months and up to £9m on the third anniversary of the deal subject to performance criteria, for one of the UK’s largest P2P lending platforms.

Industry website AltFi reports that RateSetter’s retail-investor marketplace of loans will be closed to new investors, with all future unsecured personal loans funded by the bank’s own deposit base. RateSetter’s rival Zopa is still offering a marketplace in loans, but is now focused on becoming a digital bank.

The share price of Funding Circle, which specialises in loans for small businesses, has plummeted. It has also stopped taking retail investors’ money, as property specialist LendInvest did years ago. Add in the liquidation of property-lending platform Lendy, a process that keeps exposing more problems, and it is not hard to understand why the internet is full of stories featuring the phrase P2P RIP. And just to rub salt in the wound, every month seems to bring news of yet another online platform closing. The latest is an outfit called CrowdLords.

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Retreating into a niche

In truth the story is little more complicated than this bleak picture. P2P growth will almost certainly stall, but the sector isn’t entirely going away. It’s just becoming more niche. Online lending platforms such as Assetz Capital and Folk2Folk continue to grow and there are still relatively new players, such as Fitzrovia Finance, building a customer base in areas such as property lending. The idea of lending money directly to borrowers via an online platform isn’t about to vanish – it’s just not about to storm the citadels of modern banking and investment and grab huge market share.

Nevertheless, it is worth asking what went wrong. Why hasn’t P2P lending become much more mainstream? I, like many other observers, thought that the internet offered the perfect platform for cutting out the middlemen: the big lenders and all their excessive charges and bad practices.

I assumed it would provide direct access to a decent, differentiated source of income for investors. My hunch was that these platforms were especially interesting for the more experienced investor looking for more yield than traditional savings accounts protected by the Financial Services Compensation Scheme (FSCS), the state-backed guarantee, had to offer.

However, offering services to retail investors has proved problematic. Chasing customers online is an expensive business, as the online robo-wealth advisers are now discovering, and it is not made any easier by increasingly stringent regulations by the Financial Conduct Authority, the City regulator, designed to stop mass marketing of illiquid securities to private investors.

Many platforms such as MarketFinance (formerly known as MarketInvoice) and LendInvest made the decision earlier on to focus only on big institutional investors, and they have continued to grow. Catching the attention of the UK high street is expensive, time consuming and probably best left to big brand names whom the public “trust” – haltingly – with their valuable capital.

Even if these challenges are overcome, problems remain. Most investors are only willing to spare a small amount of capital as an experiment, making it hard to see how the numbers add up for online platforms. No wonder. Over the last few years the net return after fees and potential losses on lending has tended to be between 3% and 5%.

That’s better, but not vastly better, than nearly every savings account protected by the FSCS. Many investors have concluded that an extra 1% or 2% a year isn’t worth the bother. And there is also, of course, the nagging fear that a recession always seems to be around the corner, at which point losses would suddenly increase rapidly, perhaps wiping out any yield that year.

One final challenge arguably makes that worry about risk even more acute. For most of the last decade the big legacy banks have had access to astonishingly cheap funding from the Bank of England. That has allowed them to lend at incredibly low rates to all manner of borrowers, including the small businesses P2P lenders often target. With banks creaming off the prime borrowers, the nagging suspicion has been that alternative lenders have been chasing ever-riskier borrowers who are more likely to default when the going gets rough.

A light at the end of the tunnel

That said, at some point in the next 12 months the potential storm of defaults that is on its way will fade from view and prospects for online lenders will suddenly improve. With interest rates probably still stuck close to zero, and the economic picture brightening, a boost in yields from direct lending online might seem hugely attractive to investors who are always desperate for more income – especially if stockmarkets have already priced the brightening outlook into share-price valuations. At that stage we might witness a sudden recovery in the online-lending market as investors intensify their scramble for yield.

One final observation. Even investment trusts became involved in the P2P lending revolution. One, known as P2P Global Investments (P2PGI), raised close to a billion pounds to invest in the sector. A few years ago it ditched that strategy and brought in a new manager called Pollen Street. It also renamed itself Pollen Street Secured Lending (PSSL). The fund is now the subject of a merger offer from another listed lending fund called Honeycomb, also managed by Pollen Street.

The offer is on a shares-for-shares basis and would create a monster lending fund. In my opinion, though, it is a dreadful deal for existing PSSL shareholders, as it’s just a paper deal and leaves the fund manager Pollen Street in control – even though the board at PSSL has already started the process to replace it, as I noted in an article for MoneyWeek a few weeks ago. If I were a PSSL shareholder I would reject this offer and wait for a better deal, or push for a wind-down of the fund and return of cash. If you happen to be a shareholder, sit tight.