What to watch out for when lenders become peer-to-peer lenders
The peer-to-peer platform is increasingly being treated by some firms as a kind of accessory, a thing with which to kit out an existing lending business. If you’re just now thinking about launching a pure marketplace lending platform from scratch, it’s fair to say that you may have missed the boat. That’s why the majority of platform launches these days look for a quicker fix on the borrower side of the marketplace.
This new wave of platforms are not peer-to-peer lenders, strictly speaking. What they do is very different. They take existing sources of dealflow, belonging to established lending businesses, and seek to open them up to a crowd of investors online. Kind of like peer-to-peer, but not really.
Firms that have taken this approach in the UK include Octopus Choice and Orchard Lending Club. The model is becoming increasingly prominent in mainland Europe, where companies like TWINO, Mintos, Swaper and Viainvest are finding some early success.
The approach comes with some advantages.
Let’s take Octopus Choice as an example. The platform plugs its investor base into the proprietary deal flow of the real estate lending business Dragonfly Property Finance (recently rebranded as Octopus Property). Dragonfly has a track record of over ten years, over £2bn in cumulative loan disbursals, and a very low historic loss rate. The firm was acquired by Octopus Investments in 2013.
When Octopus launched its P2P offering, it was able to hit the ground running in a way that few other platforms can, with the origination flow of a high quality lending business “on tap”, and a network of over 5,000 loyal financial advisors to draw on for investment.
But individual investors should proceed with caution. The P2P add-on model comes with its own distinct set of pitfalls.
Firstly, a large number of these outfits come equipped with a “buyback guarantee”, or equivalent instrument. These are distinct from provision funds, in that the parent company itself usually provides the backstop for investors. And that backstop is only as good as the company’s capacity to recompense investors.
Take TWINO, for example. The platform launched in late 2015 and has seen close to €80m invested through its peer-to-peer offering to date. TWINO currently has 4,500 investors signed up from over 30 countries, and offers those investors exposure to consumer loans in Georgia, Latvia, Denmark, Poland and now Russia.
This is what TWINO’s website tells us about the buyback feature: “TWINO will buy back loan (principal amount and accrued interest for full term), if a borrower is late with the repayment for over 30 days.”
The platform is backstopped by TWINO Group (formerly known as Finabay), a self funded holding company of short term lenders which has issued in excess of €350m in loans across Europe since its inception in 2009, and which has been profitable for the last 5 years.
Orchard Lending Club offers something similar to the buyback guarantee. AIM-listed parent company Orchard Funding Group will act to “guarantee” the repayment of its investors' capital in the instance of borrower default.
The recently launched Latvian platform Viainvest employs a similar model, again supported by a parent lending company (VIA SMS Group).
The first thing to note is that the UK regulator categorically would not approve of the use of the word “guarantee”, and as such I can’t imagine Orchard Lending Club sticking with that for long (they’re trying to get full authorisation, after all). But perhaps the more important thing is that these guarantees introduce a layer of opacity that the provision fund mechanism – however flawed an instrument it may be – does not suffer from.
Platforms that use provision funds, like RateSetter, generally provide up-to-date metrics as to the size of and coverage provided by such instruments. No such metrics exist for buyback guarantees, but they absolutely should. In the absence of greater transparency, investors are being given the impression of capital certainty, when in reality they have a direct exposure to the wellbeing of the parent lender.
Loan selection is also a concern for this new crop of platforms. How can investors be assured of the quality of the loans that are being on-boarded onto the peer-to-peer platform, in relation to the quality of those loans that are retained by the parent lender? Investors need to understand this process, otherwise they may rightly fear that the parent lender is keeping all the best loans for itself.
Octopus’ solution to this seems elegant enough. Loans are made available on the platform through a “blind allocation process”, dependent on capacity. This technique mirrors the method through which traditional peer-to-peer lenders prevent institutional investors from “cherry-picking” loans ahead of retail investors. The way that platforms with a parent manage this potential conflict is something that investors need to be made aware of.
Finally, investors in peer-to-peer add-on platforms should seek to understand how much money is being made by the parent originator on loans. In simpler terms: they should ask what spread the platform is making. This provides more colour as to the risk that is being taken on by individual investors.
Let’s imagine an investor were being offered a gross return of 10 per cent per annum on a batch of unsecured consumer loans in Georgia. It’s easy to be seduced by double digit returns, but hold your horses. What are the borrowers themselves being charged? Perhaps as high as 20-30 per cent? If so, then investors have to decide whether they are, in fact, being fairly compensated for the level of risk that they’re exposed to.
Octopus Choice once again leads the way here, and the answer, once again, is transparency.
5 per cent of the capital in each loan on the Choice platform is contributed by Octopus, in a first loss position, meaning that investors would get their money back before Octopus in the event of a loan default. Investors also earn all of their interest before Octopus earns any for itself.
But how does Octopus make money? There are no fees for investors on the platform. Octopus makes its money in two ways. The platform charges the borrower up to 0.35 per cent per month in order to lend, and then earns a return of 20-30 per cent on its first loss strip.
Now investors may decide that they don’t like that setup, for whatever reason, and that’s fine. But the important thing is that they’re able to review this crucial information and to then make an informed decision. That simply isn’t the case for many of the new cadre of P2P add-on platforms.
Having a parent lender backstopping a new peer-to-peer lending offering could be a positive thing for investors. But if the presence of a parent is simply used as an excuse to introduce opacity, then investors should stick with the orphans.