Marketplace lending in the US is reeling. Lending Club’s founding CEO Renaud Laplanche resigned on Monday, ending a ten year run at the top of the sector’s biggest and best-known brand. Lending Club shares are down around 34% since. OnDeck shares have almost halved over the past few weeks, after the platform announced a net loss of £13.1m on the quarter. Prosper will be laying off more than a quarter of its workforce in the face of cooler demand for its loans. Per the FT, SoFi is scrambling around for cash, offering up slices of equity in exchange for institutional lending commitments. Lending rates are rising for certain risk bands and reports have hinted at a general deterioration in asset quality across the sector.
The same question will be, or has already been, asked in just about every major financial publication: “Is this the end of the marketplace lending world as we know it?” But that is not, in fact, the correct question to be asking – because you can’t necessarily take an even world-view when assessing marketplace lending. The sector in the UK is fundamentally different from the sector in the US.
Let me first issue the caveat that I by no means believe that marketplace lending in the US is done for. As Michael Baptista of Assembly Capital Advisors argued in a recent column for AltFi, Laplanche’s departure does not appear to suggest a business model flaw. Yes, the platforms are running up against a waning of demand among institutional investors – but we’ve seen little evidence so far to suggest a decline in the performance of the marketplace lending asset class. The sector is clouded by uncertainty at present. This may well be acting to distort the market’s impression of loan assets that are in fact performing as anticipated.
Regardless, let’s switch focus to the UK market. Clearly the platforms on this side of the pond will face some fallout as a direct result of events in the US. The pace of equity fundraising has certainly slowed in the UK of late. We’ve covered only one major fundraising round this year (LendInvest’s £17m Series B). Last year we covered little else. If it hadn’t already become more difficult for the platforms to raise equity capital, it certainly will be for the foreseeable future. It will also become harder for UK platforms to secure institutional debt funding. The sector’s largest fund – P2PGI – has deployed its £870m in share capital, and is quickly burning through its leverage. More or less the same can be said for its rivals. New institutional lenders will now – in light of the US context – be more cautious about dipping their toes into the marketplace lending space, thus lowering the wall of institutional funding that has for so long been said to tower over the sector.
Furthermore, UK industry participants will now be subject to a far higher degree of scrutiny. We’ve seen evidence of this already. RateSetter was recently forced into a strategic about-turn, after revealing that it had been investing a proportion of its provision fund in loans that were listed on the platform. A negative reception from the company’s investors prompted the change of tack. The incident attracted a considerable amount of coverage in the press. It’s natural to assume that the spotlight will henceforth shine all the more brightly on the internal controls and procedures of the UK’s market leaders, given the nature of Laplanche’s resignation.
But is there not also cause for optimism in the UK? Marketplace lending (or peer-to-peer, if you’d prefer) has taken hold in four major global markets: the US, the UK, Continental Europe and China. Of those markets, the US is currently under the cosh, Europe has suffered the demise of TrustBuddy and China is in a state of disarray. The UK has had its hiccups, but is yet to endure a period of sustained distress. Why is that? What sets the UK marketplace lending model apart?
The first and most obvious differentiator is the type of investors that have fuelled the growth of the UK industry. The UK market is famous for its focus on retail investment, with the major platforms only turning to institutions during the past couple of years. The graph below reflects AltFi Data’s estimate of the breakdown (institutional vs. retail) of lending in the UK’s marketplace lending sector, over a period of 2 to 3 years.
As can be seen from the latest monthly figures, institutional funding continues to play second fiddle to retail investment, accounting for about 40% of monthly origination volume. Rhydian Lewis, Founder and CEO of RateSetter, commented:
“Lending Club pioneered the industrialisation of marketplace lending, especially with regard to institutional capital – in many ways, the UK has chartered a different path with our focus on the retail investor. I believe that the future for our industry is to engage large numbers of individual investors, rather than focusing on fewer institutional investors as in the US.”
“We believe in maintaining a diverse set of funding sources which includes both individual and institutional investors. We are very proud of our ongoing institutional partnerships including P2PGI and Metro Bank as they allow us to provide a consistent and excellent service to our borrowers. The way we run our business is that we look at the growth of our borrowers and our lenders, find the difference and use the institutional money to fill the gap.”
“Having the institutional money as a buffer means we cannot over-fund and ensures that our individual investors’ money is lent out at a more predictable pace with the institutions being a buffer that accounts for the volatility of demand.”
UK platforms have also been considerably more cautious than their US counterparts in turning to ABS markets. Securitisation has long been an important part of the capital mix stateside, while also playing a significant role in the US sector’s recent growing pains (see, for reference, the Prosper-Citigroup fracas). The UK industry’s debut securitisation was announced a little over a week ago. KLS Diversified executed a securitisation of Funding Circle loans, selling part of the senior tranche to the German development bank, KfW. Deutsche Bank acted as sole arranger and lead manager for the transaction. The European Investment Fund, part of the European Investment Bank Group, guaranteed the senior tranche of the offering, adding significant ballast to the deal. The involvement of a supra-national entity like the EIF was a highly positive endorsement for the UK sector, particularly given the counter cyclical nature of its funding.
The structuring of the sector’s inaugural securitisation is indicative of the conservative nature of UK industry as a whole. The world’s first peer-to-peer lender Zopa was able to effectively safeguard the reputation of the emergent P2P sector during the 2008 downturn, thanks largely to a highly conservative credit selection policy. The platform’s net returns never fell below 5% during 2008, according to the Liberum AltFi Returns Index (LARI).
That same conservatism is reflected in the fact that none of the UK’s platforms are listed. LendInvest is the only platform in the UK to have even been linked to a listing, and that rumour dates back to February 2015. Being a public company comes with its own set of challenges, and the UK players have to date been measured in rising to them – perhaps wisely electing to stave off that level of scrutiny until all processes are sufficiently developed.
Peer-to-peer lenders in the UK set about lobbying for their own set of dedicated industry regulations with the formation of the Peer-to-Peer Finance Association (P2PFA) in 2011. The FCA duly obliged in 2014 by implementing its interim permission regime for peer-to-peer lending platforms. The UK’s major lenders now stand on the brink of receiving full authorisation from the regulator. The FCA’s oversight of the sector in the UK is the only example of a dedicated P2P regime globally. Funding Circle CEO Samir Desai offered his thoughts on this:
"The regulatory regime established in the UK by the FCA for marketplace lending platforms is the only one in the world which has been designed specifically for our business model. I believe this and the best practices adopted by P2PFA members, puts the UK market in a strong position for the future.”
“When the US regulator decided to force fit the idea of P2P lending into the existing regulatory framework it created a number of simmering tensions and pressures on those businesses and the way they operate. This is in contrast to the UK where the focus was on making sure that consumer protections were proportionate to the risks, and that innovation was not stifled by applying rules for the sake of having rules – possibly with an eye to the interests of incumbent investment models.”
The “simmering tensions” referred to by Bruce relate to the US’ exportation model – whereby loans must be originated by a bank prior to being sold on to a marketplace lending platform. This method of funding loans is at the heart of the Madden vs. Midland court case, which – to cut a long story short – may end up meaning that a portion of Lending Club loans are in breach of state interest rate caps.
The UK’s marketplace lending sector also enjoys the support of the government – perhaps more so than any other industry around the world. It’s not quite so relevant a point in assessing whether the sector need be concerned by developments in the US, but UK platforms have to date been supported by a number of government initiatives. There’s the much ballyhooed Innovative Finance ISA, the mandatory bank referral scheme, P2P’s eligibility for bad debt relief and funding from the British Business Bank. The US government, by contrast, is still caught up in exploration mode. The US Treasury has scheduled the release of a white paper for this week – one that will outline recommendations for the marketplace lending industry. The report will mark the end of a near 12 month inquiry process.
Finally, but perhaps most importantly, we come onto the matter of transparency. It’s particularly relevant here because it ties in with many of the problems that have arisen in the US market. Claims of deteriorating asset quality in the US marketplace lending sector could have easily been squashed at the outset if the platforms were able to point to a de facto representation of their performance. But no such resource exists.
Not so, however, in the UK, where the Liberum AltFi Returns Index provides an as-live, loss-adjusted representation of the performance of the UK’s marketplace lending sector. This blended line of 12 month historic return is powered by loan-by-loan, cash flow level data from four of the sector’s largest platforms – Zopa, Funding Circle, RateSetter and MarketInvoice. And whilst we’re on the subject, the absolute return figure that is reflected by the index has been trending upwards over the past 6 months.
It is a requirement of the P2PFA that member platforms publish their full loan books online, providing investors and industry observers with a level of transparency that exists in the US sector on a purely selective basis – i.e. an institutional investor may be privy to performance metrics that are not made available to all investors. These are the sorts of imbalances that appear to have upset the apple cart at Lending Club.
The intention here is not to hold the UK sector up as some sort of glistening paragon of all that is good and right. Rather it is to elucidate the steadier, but perhaps surer, style in which the industry has evolved. As Funding Circle boss Samir Desai put it:
"Over the last five years we have introduced a diverse range of investors to the Funding Circle marketplace, including thousands of individuals, local councils, governments and the Funding Circle SME Income Fund. This has led to prudent and sustainable growth of our platform."