How will P2P fare in a worst-case Brexit scenario?
AS PRIME Minister Theresa May goes back to Brussels in a bid to get MPs’ backing and push her Brexit deal over the line, a ‘no deal’ scenario is looming large.
While a lot of Brexit uncertainty has been priced into markets and sterling since the vote to leave the EU in 2016, there could be further market shocks if Britain plunges over the cliff edge. But what would the impact of a disorderly exit be on the peer-to-peer lending sector?
Neil Faulkner is co-founder and managing director of 4thWay, a ratings and analysis firm for the P2P industry. He notes a turbulent Brexit would see the number of defaulting loans on some P2P lenders’ books triple and would lead to cut-price sales of borrowers’ assets. However, he adds that interest rates and reserve funds are prepared for most disasters, leaving “a very low chance of a sizeable overall loss” on well-diversified, low-risk lending portfolios.
Read more: Brexit-proof lending
4thWay reports that risks and bad debts have risen in the P2P space over the last five years, in line with its predictions. However, platforms have remained resilience in spite of this. The reasons for the trend are that one, benign lending conditions have reversed, and, two, platforms cannot afford to be as selective with their lending as they could in the early days of P2P.
Zopa, for example, only approved 0.5 per cent of personal loan applications in its first year, but now it grants 20 per cent of applications, an approval rate much more in line with the big banks.
“Default rates have risen somewhat, but losses have still been easily contained by interest, reserve funds, and selling security as a last resort,” says Faulkner. “It is startling how stable lending is and a refreshing change for many investors.”
4thWay uses stress tests that it says are stricter than the Basel tests that banks have to undergo, in order to assess how P2P platforms would do in the event of a severe downturn comparable to the Great Recession, which it describes as a 1-in-100-year event. The research house reports that many P2P lenders have held up well, showing that lenders who diversify across a decent basket of those top-rated sites and hold on to their loans until the borrowers repay them can expect to survive such a disaster with positive results.
But what about those lenders which do suffer losses related to Brexit? Faulkner says returns will not be even across the board, and some lenders can expect to lose. However, if they have been lending sensibly, their losses should be lower than stock market falls, and can be recovered in the following years. The ones at risk of heavy losses will be “the ones who don’t take steps to diversify very widely across thousands of loans and six to 12 lending platforms, or the ones who lean towards higher-risk, higher-rate services,” he says.
“Anyone panic-selling during a recession might also expect to come out with less than they started. Some things never change,” he adds.
Global investors are already turning their backs on UK equities, with allocations to the asset class hovering near record lows, according to Bank of America Merrill Lynch’s fund manager survey. But Faulkner said investors may still want to back alternative investments such as P2P because they are less volatile than investing in stocks.
“The worst-case Brexit scenario would see a substantial recession, impacting jobs and profits, as well as the property market, causing bad debt write-offs to rise as much as fourfold, although I expect most lenders using many 3 PLUS-Rated P2P products and Innovative Finance ISAs to survive the blast,” he comments.
“In the best-case Brexit scenario, lenders will have a soft landing, and the extra interest they earn over the period will form an additional nice buffer before the next crisis, whatever and whenever that may be.
“Some investors are using this asset class to get high yield, with riskier property or asset-based lending, and I can sense the greed. It is not impossible for investors to achieve high yield, even after bad debts, but most lenders would be wise to play a longer, lower-risk game, which is where lending usually shines best. It surely will during a Brexit meltdown scenario.”