One of the biggest rubs on marketplace lenders is that they haven’t been through a downturn. Ben Conway, co-manager of two Hawksmoor funds, recently told AltFi that he would be avoiding the nascent marketplace lending space for the foreseeable future, because the platforms haven’t yet been through a cycle, and are altogether “too new”.
In response to this sort of stance, several of the biggest players in the marketplace lending sector – most notably Funding Circle – have subjected their loanbooks to stress tests.
Funding Circle has run a number of these tests over the past few years, most recently in September, in part prompted by Brexit. The platform's institutional lending partners called for a show of post-Brexit resilience, and Funding Circle delivered.
The platform subjected its loanbook to two stress tests: its own scenario, which mirrored 2008/9 conditions, and the Prudential Regulation Authority’s 2016 stress scenario, which is considerably more severe.
According to a Funding Circle representative, the latter of these is the exact same test that the UK’s biggest banks were recently forced to undertake, and which the Bank of England published the results of yesterday. The conditions are as follows:
Yesterday we learned that RBS had failed the test, and had been forced to devise plans to bolster its balance sheet by £2bn via cost cuts and asset shedding. RBS is still 73 per cent owned by the British tax-payer, after being bailed out in the global financial crisis.
Both Barclays and Standard Chartered flirted with failing the stress test, but managed to squeeze through.
Now let’s remind ourselves of how Funding Circle fared under the same set of conditions: its existing portfolio was projected to yield 5.7 per cent, down from 7.2 per cent under prevailing market conditions, while new loans were projected to deliver a net yield of 3.9 per cent.
Clearly there can be no direct comparison between a bank and a marketplace lending platform, given the breadth and complexity of the former’s activities. Indeed that lack of comparability is among the greatest strengths of the marketplace lending model. Marketplace lending is not complicated (in most cases); it’s simply an exercise in matching capital and demand, using the internet. If the platform itself fails, the loanbook can in theory be wound down in an orderly fashion.
In a spectacular about-turn at a recent industry conference, former boss of the City regulator Lord Adair Turner, said that direct lending could add a “spare tyre” to the credit supply system, making credit crunches less likely. His argument was based on a belief that a system of direct lending is not subject to the risk of funding runs, which he said “is inherent in any system of bank maturity transformation”.
Given that Funding Circle was able to “succeed” (i.e. continue to deliver positive net returns to investors) where a major high street bank failed, could we see a spate of Turner-esque changes of heart among investors?