By Nick Moules on Friday 21 February 2014
Zopa celebrates 10 years in business next year and everyone else in the p2p industry should doff their caps to the founder members for being brave, innovating and creating a new market.
Given the success of Zopa, it’s a little strange that institutional money, now driving the US p2p market, has stayed largely absent from the UK market.
The clue might be in the gross returns available through lending to prime UK consumers, with Zopa quoting a projected return of 4.9 per cent after fees on lending for up to five years. Fantastic rates for the consumer who has endured record low interest rates for years, but it’s close to retail product rates and not eye-catching enough for the institutions.
It’s impossible to criticise Zopa, it takes a low-risk approach to its borrowers and has created a great deal of trust in themselves and the industry.
But they do things slightly different in the US, with rates rising all the way up to 26 per cent for Lending Club’s riskiest borrowers.
As a result, the institutions have snaffled the loans up, so much so that Lending Club has now placed restrictions on institutions buying loans, for fear of alienating the retail investor.
Parallels in the UK p2b market
In the UK, the business lending market is perhaps the most enticing for institutions because of the high rates of return available. On rebuildingsociety.com for example, we allow lenders to lend at rates up to 20 per cent for C-rated borrowers.
After conceding several years and millions of pounds in a headstart to the likes of Zopa and Ratesetter, the peer-to-business / p2b market is catching up and will overtake the p2p market in lending volume, and it’s able to offer higher rates of interest to lenders. Deal size is rising all the time and it is inevitable that organisations with turnover of over £100m will start to look at the market for their financing options.
Why now for institutions?
Transparency and data are two big themes in the p2b market. Loans are maturing, so platforms and lenders have a clearer sight of risk. In the next 12 months, the market’s first five year loans will start to mature, proving or disproving the theory that longer term loans are inherently more risky.
This means data can be scrutinised and more calculated lending decisions made – at the moment spreading risk seems to be the principal investment mechanism.
When running loan portfolios through calculators, it’s important to bear in mind that when these first peer-to-business loans were made, industry norms around security did not exist.
There were completely unsecured loans for example.
Now, those lending the money demand good levels of security, so an asset (either personal or commercial) or all business assets are usually offered as collateral, especially on loans above £50,000. There are those lending in the market that place high value on a personal guarantee from the company director (it prevents a business ‘pre-packing’ and writing off unsecured debt) and those that see little value in it (believing they’re difficult to enforce), but it can never hurt to have this in place.
High gross returns
Nonetheless, data and double digit returns interests those whose profession it is to build portfolios for their clients.
Family offices, insurance companies, hedge funds, asset managers, and hopefully ISA managers, will all be able to make a huge impact on the market. At the start of February, the p2p and p2b markets in the UK were worth nearly £1bn in loan value combined. What might be considered expendable or small change for some institutions could dramatically improve liquidity and force a dramatic change in the way the market views itself and behaves.
With average gross annual returns through rebuildingsociety.com hovering at the 15 per cent mark and a solid spread of loans from which to buy a portfolio, what could be the smallest experiment on the books, might just perform the best.
The compelling reasons
It’s easy to casually observe this market and say; “it must be risky, look at the returns.” However, the reality is, these are good quality UK businesses offering good collateral in return for a loan to grow, and the business loan market has existed for a long time. Their rates haven’t changed a great deal, but they benefit in other ways, like getting a loan in days rather than months, as is sometimes the case with banks, and they can refinance at any time for no extra or hidden charges.
The margin for the lender is created by the low fees (or non-existent management fees) charged by platforms.
Unlike international banking behemoths, platforms are lean operations that take advantage of leaps forward in technology to create sleek and inexpensive solutions. Further advances in payment technology will only improve the customer experience and break banks’ monopoly in the space, further increasing the funds and improving the quality of business borrowing.
In the future, there’s nothing to say we can’t all lend directly to global organisations in the same way we’re lending to local SMEs. If the value is there for both parties, the market will be created.
As diversification in the space quickens, there will be increasing opportunities to make investments that match brand or client values. Loans to ethical companies, companies in a particular sector or with connections in growth markets will be possible on a grander scale. People want their investments to mean something and this industry will facilitate that.
A seismic change in the business loan market is coming and now is the chance to test investment strategies and be part of it.