Entitled ‘Marketplace lending: A temporary phenomenon?’ the report concludes that in the main alternative financing from online platforms is not a material threat to banking as the dominant lending model.
However, the report’s author, Deloitte’s head of banking Neil Tomlinson, says the increasing number of funds and investment trusts allowing investors to access marketplace/P2P and direct lending “is a potential risk to banks”, in particular in certain niches.
“This [risk] is that market place lenders might provide easy access to a new, higher-yielding asset class for those deposit-holders whose low returns currently provide banks with their advantaged funding base. This advantage is the key to banks being able to sustain their position on the borrowing side of the market,” Tomlinson said.
“We believe marketplace lenders are likely to secure a strong foothold in areas of the market where banks do not have the risk appetite to compete. This will form a bridgehead from which they can expand at those times in the cycle when banks are pulling back from lending or relying on super-normal profits in order to cross-subsidise other parts of their business,” he added.
Source: Liberum AltFi Returns Index
There are now a small but quickly growing universe of investment trusts listed on the London market that fit in into the alternative credit label. These include the likes of the £868m P2P Global Investments, £381m VPC Specialty Lending, £157m Ranger Direct Lending, £147m Funding Circle SME Income, £100mm Honeycomb and £53.2m GLI Alternative Finance.
They are mostly portfolios of SME and consumer facing loans with broad geographic exposure, low duration and typically relatively small in size and offer attractive yields of 5-10 per cent.These generally can come in the shape of private placements of company debt, securitised loan funds and direct lending through channels such as market placer loan platforms.
These recent launches have been quickly taken upon by some of the largest institutional investors in core fixed income such as BlackRock and M&G. Investment managers are increasingly attracted to these marketplace/P2P funds for two key reasons, Tomlinson argues.
Firstly the substantially higher headline yields on offer than many other fixed-income assets, adjusted for duration and default risks.Secondly for the perceived diversification benefits that these funds can bring, due to less correlation to other more core assets such as global equities.
“Chasing this opportunity, European fund managers have raised around $170bn over the past five years to invest specifically in private debt, with a marked acceleration since 2012,” he said.
Despite this nascent growth from institutional investors he adds that banks’ ‘low-cost funding model’ means they retain a powerful competitive advantage.
“This is likely to prove even more powerful when and if base rates rise. As a consequence, we do not foresee banks being systematically displaced from their core roles of lending to retail consumers and small businesses, and collecting deposits from those segments.”
“Historically, exposure to this asset class has largely been provided by players such as hedge funds, limiting its availability to select investors. However, increasing longevity means the requirements of all savers are growing more demanding, as they need their savings to last longer while also using them for income.”
However, as traditional asset managers are responding to this ever greater demand for income-generating investments, they are moving away from traditional exposure to equities and bonds.
“Both models are converging, with hedge funds seeking to expand their investor base through more retail offerings, and traditional asset managers increasingly offering specialised funds to compete for market share. The resulting ‘democratisation’ of alternative asset classes, including lending, appears set to drive a major boost in demand.”
The charts below compare the risk-adjusted returns offered by marketplace loans compared to those from equities, using credit card lending as a proxy.
Tomlinson said: “This data suggests that market place lenders’ annual risk-adjusted returns are competitive with equities. Specifically, while direct lending has underperformed the S&P 500 index over the past 20 years, it has not had any negative return years and has been much less volatile.”
He says this will mean the majority of disruptive growth will come from credit funds investing in securitised assets or secondary loans, rather than from investors putting money directly into platforms to specific individuals. The creation of a secondary market for loans will subsequently improve liquidity.
In particular, institutional investors such as pension funds will be a big driver of demand. This is because they typically have longer investment horizons, can provide stable funding to the sector. While providing much needed stability to the budding sector, this will also help to ‘professionalise’ marketplace lending, he adds.
“As asset managers increase their exposure, marketplace lenders will need to ensure that they can deploy incoming proceeds efficiently without ratcheting up risk. Initial asset manager interest will be in relatively larger loans (by size). However, as more asset managers enter the space, they will have to invest in smaller loan sizes due to both limited supply and the need to diversify their exposure.”
“At that stage, large asset managers may need to compete directly with (or indeed swallow) marketplace lenders to access the asset class”