Last week, David Stevenson, the Financial Times’ Adventurous Investor, wrote: “any altfi or fintech platform engaged in consumer lending will, by my estimation, probably be forced to turn into a bank at some stage in the not too distant future”. He sees lower cost of capital as one of the key factors in forcing the conversion.
But there’s a problem. Zopa is the world’s original peer-to-peer lending platform and the biggest consumer-focused platform in the UK. It has also been closed to new investors for the better part of eight months. The reason is explicitly that it cannot find enough new borrowers. Demand for its loans among existing investors is more than sufficient to match demand on the other side of the marketplace. For this reason, Zopa's Innovative Finance ISA has largely been an exercise in tax efficiently wrapping money that it already had on the platform. The platform told the Financial Times last week that it hoped to reopen to new investors in early 2018.
In the meantime, the company is careering towards getting a banking licence – which will allow it to accept retail deposits. This money will be used to fund loans through its marketplace lending platform, which will operate adjacent to the bank. The hope is that this will lower the company’s cost of capital. But hold the phone: if Zopa can’t currently find enough borrowers to satisfy the demands of marketplace investors, where on earth does it intend to find willing recipients for its deposit capital?
Zopa has said time and again that it will not compromise on credit quality. In other words, it will not begin lending to riskier borrowers in order to get money out the door. In fact, the platform is currently in the process of cutting back on its riskiest loans. No matter how much money it has to lend, a loosening of credit standards is not the answer for Zopa. But what is?
The business is planning to roll out a number of new borrower-facing products as part of its bank launch. These include credit cards, auto-finance, point-of-sale lending and overdraft products. Zopa’s CEO Jaidev Janardana (pictured), formerly of Capital One, once told AltFi in an interview that these products “don’t necessarily lend themselves to a P2P model”. That’s all well and good, but he also said in that same interview that Zopa’s bank would fund personal loans on the P2P platform, via its institutional whole-loans market, on the same terms as any other institution. The problem remains: there’s no room at the inn! Not for individuals, and not for banks.
A more meaningful initiative in the platform’s ongoing plight to attract borrowers might be its latest partnership with Saffron Building Society. This, for the first time in Zopa’s 12 year history, brings it into branches. Its loans will now be made available to Saffron’s 90,000 customers in any of its 11 branches across Hertfordshire, Essex and Suffolk, as well as via the building society’s website. Applicants can expect a quote within minutes.
The Saffron deal is a bit more like it. Sign a half dozen more of those, and suddenly Zopa is beginning to infiltrate the one place you’d have never expected to find it: the high street.
There is another tailwind for Zopa’s chances of finding new customers. From early next year, PSD2 will open up frictionless access to bank account data for a whole host of third parties. Here’s what Janardana told AltFi about the scheme in June: “Thanks to PSD2, I am able to simplify [the customer’s] total financials and help them take control. Because we understand them and we understand the data, we are able to present it in both insightful but also intuitive ways that they can understand and play around with. Within that they might choose to get our products or they might choose to find different products but we will facilitate that and help them get better control of their finances.”
By the sounds of things, Zopa is banking (excuse the pun) on its ability to spin superior insights out of the data made available by PSD2, and so win more customers for its lending products.
There’s certainly no denying that Zopa has an edge and a track record in utilising data through technology. Making use of bank account data in an Open Banking environment may allow the lender to address a broader segment of the market – without compromising credit quality. The idea is that some borrowers may very well sit within the parameters of what the platform deems acceptable, but are misrepresented by incumbent credit bureaux, upon which Zopa remains heavily reliant. Zopa’s hope is that PSD2 data will unearth gems at the fringes of its credit models.
That the platform is attempting to find means of doing this is evidenced by its recently-announced partnership with next generation credit scorer Aire, which raised $5m in a series A in July. Aire claims that it can empower banks and other lenders to serve more consumers without having to broaden their risk parameters. Just what the doctor ordered.
There are signs that Zopa will be able to tap new borrowers over the coming months and years. The question is whether it will be able to reach enough. Of course, there’s also a philosophical question about the act of becoming a bank, and what that means for P2P.
Not all P2P lenders believe becoming a bank is the right way. In fact, you could argue that most don’t. Funding Circle’s CEO Samir Desai gave a keynote speech at this year’s AltFi Europe Summit entitled: “”, and sided firmly with the latter course. Speaking at MarketForce’s recent Future of Lending conference, Rhydian Lewis, CEO of RateSetter (a major rival to Zopa), rebutted the claim that peer-to-peer lenders want to become banks.
“Peer-to-peer lending is optimised to deliver value, whereas banking is focused on providing certainty,” said Lewis. “The place for rainy-day savings is generally going to be a bank, but for the opportunity to put your money to work, accepting some risk, investing in peer-to-peer lending is a great choice.”
Zopa, of course, wants to offer both options.
Another potentially troubling aspect to Zopa’s ongoing attempts to find balance is its withdrawal times. In a market overweight with investors, one would imagine those investors would be able to sell out of loans via the secondary market with relative ease, as there should in theory be buckets of money champing at the bit to replace them. Yet this is not the case for Zopa.
Of late, AltFi has received multiple notes from investors flagging the fact that withdrawing money from Zopa is taking longer than the expected 2-3 days. Zopa itself has acknowledged this, attributing it to a lack of “technical capacity”. Joe Hutchinson, a senior developer at the firm, blogged in September about how “being more efficient in finding buyers and reducing the number of actions needed to complete a sale” had increased the speed of loan sales by a factor of ten. Zopa has also given the loan sale process “more room on the server” in an effort to further speed up the process.
Should those efforts prove successful, we should expect to see withdrawals processed very swiftly indeed, given the excess of capital on the investor side. But time will tell.
Thus far, I’ve skirted around the elephant in the room: that consumer credit conditions are quickly deteriorating. Multiple warnings from the Bank of England and events such as the collapse of “doorstep lender” Provident Financial’s share price and the emergence of “problem debt” areas in the UK have underlined this, as have events at the UK’s biggest P2P consumer lender (which, incidentally, is active in several of those problem debt areas).
Zopa’s chief product officer Andrew Lawson wrote to investors in August to inform them of higher than expected loss rates on non-Safeguarded loans, and consequently of lower-than-expected return projections. He said that publicly available data suggests that consumer default and insolvency levels had grown closer to historic norms prior to 2010, after a period of historically low levels of bad debt over the past seven years.
Having already absorbed some damage on its outstanding loan book, Zopa was forced to cut back on its riskier lending, in particular in its D-E risk bands. The company said it was taking steps to attract a greater volume of lower-risk borrowers, in an effort to increase the proportion of A and B loans in its portfolios. These moves brought its targeted returns down to 4.5 per cent for Plus investors, who take the full spread of available risk, and 3.7 per cent in Core, where investors take exposure to A*-C loans only.
Zopa recently transitioned to its Core and Plus products as part of a plan to phase out its Safeguard fund, which can cover investors in the event of a loan default. Zopa’s investment accounts were previously entitled Access, Classic and Plus. As recently as September 2016, target interest rates for these products were 3.3 per cent, 4.1 per cent and 6.5 per cent respectively.
Since then, Zopa has been forced to slash its interest rates multiple times, responding to a more competitive consumer credit market post-Brexit. Banks and other lenders have been forced to adjust their rates similarly in response to base rate cuts by the Bank of England – and Zopa has had to follow suit.
Recent data on the importance of price comparison sites as an origination channel in P2P would suggest that Zopa has managed to stay competitive. Approximately half of the platform’s loans are sourced via sites like MoneySuperMarket and Confused, which would suggest that it is often going toe-to-toe with banks – and winning. This is an important point. In a low-rate environment, Zopa – which, remember, is constrained by borrower demand – in a simplistic sense has two choices: cruise down the credit curve in search of new borrowers, or batten down the hatches and perhaps forego growth in the short-term by relentlessly pursuing low-risk customers.
Zopa seems to have opted for the latter course. That move may have a long-term payoff.
One thing that might derail that payoff is if its returns keep falling. It is, of course, expectable that returns would decrease somewhat, as a result of the platform’s repeated cuts to interest rates and attempts to de-risk investor portfolios. Having said that, Zopa’s 12 month trailing return (net of losses and fees) hit an all-time low of 2.69 per cent in August, according to sector specialists AltFi Data. That’s lower than during the financial crisis (although it should be noted that Zopa was lending significantly less money at that time). Its all-time high of 6.38 per cent came in May 2012.
With Bank of England governor Mark Carney recently flagging a potential rise in interest rates, perhaps Zopa’s returns will rebound. But with its renewed emphasis on low-risk loans, returns are unlikely to rise far.
It plans to launch a savings product. But for its investment product to stay relevant, it must offer a clear risk-premium. 2.69 per cent might not cut it. But it wants to remain competitive and prudent, and so low interest rates are a must. But this makes it harder to originate borrowers, which has forced it to close to new investors. It wants to use deposits to fund loans on its marketplace (in addition to other products), thereby lowering its cost of capital, but there simply isn’t enough origination to allow for this at present.
Zopa may well have a bright future, but in the short-term it seems to me that it has three core issues that it must iron out:
Finding new origination channels in order to open to new customers once more, capitalise on the IFISA opportunity and take advantage of the cost benefits of deposit funding.
Meaningfully speed up whatever is delaying loan sales on the platform.
Find a way to maintain an attractive risk-premium for its P2P investors.
Update: Zopa correctly points out that the original version of this article failed to mention the fact that the platform has experienced significant growth in lending volumes lately, despite tightening who it lends to. The company is on track to to lend £1bn this year. It lent £690m in 2016.