In the beginning
CONSUMER lending is the oldest segment of P2P, but can it retain its competitive edge against newer and bigger types of P2P finance? Andrew Saunders reports…
Consumer loans may have been the original peer-to-peer product, but are they still the best? When Zopa first started cutting out the banking middleman back in 2005, bringing together investors seeking better returns with borrowers seeking a quicker and more hassle-free way of funding that new kitchen, TV or car, there was nothing else like it around.
Fast forward a decade and a half and the landscape has changed considerably. Consumer lending is by no means the only – or the biggest – kid on the P2P block any more.
The latest annual UK Alternative Finance Industry Report, compiled by the Cambridge Centre for Alternative Finance (CCAF), found that business lending made up the largest share of the P2P market as of 2017, followed by consumer lending, with property finance a close third.
Throw in the fact that for many mainstream investors, the razzmatazz surrounding Funding Circle’s initial public offering was their first exposure to a P2P lender, and a model which started out serving consumers now seems to have morphed into one that is becoming better known for its business credentials.
It’s a shift that is at least partly explained by the differing nature of the assets involved, says Jake Wombwell-Povey, chief executive of direct lending investment manager Goji. “Business lending is on the rise because individual investors are drawn to business and property loans,” he comments. “They tend to be asset backed and have more security.”
He argues that security is particularly appealing to retail investors because, in the absence of Financial Services Compensation Scheme guarantees, loans secured against an asset like a warehouse or factory can seem like a better place to put your hard-earned cash. “These are not the kind of investors who want to spend their time analysing credit risk,” he asserts. “But they do understand bricks and mortar.”
Wombwell-Povey thinks that business lenders have taken lessons in how to promote themselves from the consumer lenders that predated them. “There is still growth in consumer lending, but other parts of the market are getting more fluent in marketing what they do to consumers,” he says.
On the other hand, the consumer lenders’ head start in the market means they are now more mature businesses, says Peter Behrens, co-founder of ‘big three’ platform RateSetter, which started life as a P2P consumer lender before diversifying into business and property finance. “We diversified much earlier and more aggressively than some,” says Behrens. “We tried lots of different lending verticals and dabbled in different ways of raising the funding supply too.
“Some were brilliant, some not so much. But it has given us the focus now on how we can relentlessly grow the business. Our instinct is to get the product right, and then once the formula is correct to try and amplify it. That focus is very valuable.”
Although RateSetter has diversified into other types of loans, its original consumer product still accounts for the lion’s share of its loanbook.
In comparison with younger platforms, RateSetter (and the other ‘big three’ platforms Funding Circle and Zopa) have had more time to establish both their individual models and their market positioning relative to one another, he adds. “I think that the three of us are all focussed on something slightly different,” says Behrens. “Funding Circle wants to be the best small business lender in the world. Zopa considers itself to be the best consumer lender in the UK, while we at RateSetter are focussed on being the best retail investment product that can get its hands on these types of assets.”
So the ‘big three’ may not all compete directly for borrowers, but they do compete for investors, and each has a distinct offering. The important point, says Iain Niblock, co-founder and chief executive of P2P investment manager Orca Money, is that investors can and should include both consumer and business lenders in their portfolios rather than trying to make a decision on which is best. “There are good quality assets to be had in consumer, business and property lending and it’s good to have investments split across the three sectors,” he explains.
While much of the attention may be on business lending at the moment, the intrinsic strengths of consumer lending remain. “There is a bigger market of consumers, you just have to offer a better product,” adds Niblock. “The returns in consumer P2P lending are actually growing.
“With consumer lending you get a lot more loans in your portfolio [for a given sum invested] because each loan is smaller, so you get more diversification.”
However, Niblock predicts that P2P consumer lenders will increasingly face rivals from outside the sector. “What’s going to impact P2P is when the challenger banks start lending,” he states. “Take Marcus from Goldman Sachs – they have taken huge deposits, what’s going to happen when they start lending to consumers?”
The challengers may prove tough to beat: P2P platforms have to provide a return to their investors, whereas deeper-pocketed challenger banks can afford to buy market share with loss-leading rates, at least in the short term.
P2P lenders must also manage the perpetual balancing act of matching the demand for loans from borrowers with the supply of funding from investors, an issue that tends to become more rather than less complex as the size of the business increases. Of the ‘big three’, only RateSetter remains fully focussed on retail funding. Zopa’s P2P investment is now approximately two thirds institutional money and one third retail.
Concerns have also been expressed that Brexit-related fears over the economy may hit both consumers’ appetite to borrow and their ability to repay, with negative consequences for origination levels and default rates. Figures released by the Insolvency Service for 2018 showed that personal insolvencies rose 16.2 per cent to reach their highest levels since 2011, with Individual Voluntary Arrangements (IVAs) at the highest annual level ever recorded.
It’s not something that RateSetter has seen any sign of so far, says Behrens. “A decent sized unsecured personal loans book – which is what we now have – is an interesting bellwether for what’s going on in the world. We see no signs of any stress in it at all.”
He’s equally sanguine on Brexit. “I’m an optimist, so despite the ever-increasing sense of woe around Brexit I think that ultimately humans rebuild stuff – solutions will be found,” he adds.
He’s careful to note that there is no cause for complacency, but also points out that if and when it does come, a bit of economic turbulence could actually be a good thing. One of the most often-repeated criticisms of P2P is that it has not yet proven its mettle through a full economic cycle.
“We’ve designed our product to manage the risk of changing economic conditions,” Behrens affirms. “That’s what we have set out to do, but we need to prove it. If we can do that in the course of this financial year it could be a real tipping point, where the growth rate in the business goes up absolutely enormously.”
P2P may have its challenges, but providing alternative consumer products is pretty tricky too. Let’s not forget that Zopa is launching a bank, a substantial undertaking driven in no small part by the flexibility to offer new products such as credit cards that having the buffer of a bank’s balance sheet brings.
One new entrant that reckons it can square the circle and provide a short-term credit-card style product via a P2P platform is Elfin Markets, a start-up founded by former Goldman Sachs banker Mansour Bouaziz. Due to launch shortly, Elfin will offer customers what amounts to a consumer version of a commercial revolving credit line – a credit account rather than a credit card, called the Elfin Purse. “We’re the first in the UK and probably the first in the world to offer this,” he says. “Credit cards are a big part of the credit market but the prices are atrocious. The average APR is over 20 per cent. Our representative APR is 5.8 per cent.”
What makes him think he can succeed where others have feared to tread? “At Goldmans Sachs I was involved in liquidity management, managing the cash the bank needed to have on hand to meet its clients’ requirements,” he says. “What we’re doing at Elfin is not that different – making sure we have enough cash to meet borrowers’ needs, but not too much. It is investor’s money and they expect it to be earning a return.”
He also thinks that the P2P sector as a whole is in need of some fresh thinking to unlock the next phase of growth in the consumer market. “There is more we can do as a sector to innovate further,” he states. “The tech hasn’t evolved that much in the past five years and the sector is also missing people who innovate on the finance side.
“We are more finance than tech – it’s the same thing that investment banks do for their clients, and investment banks are not very good at technology.”
Founded in 2016, The Money Platform is also a short-term consumer lender, targeting loans of a few hundred pounds for terms of four to seven weeks for underserved millennial customers. “The millennial generation is very poorly served by traditional lenders and credit agencies,” says chief executive Joshua Graham, because their credit record is typically not strong enough to meet the standard requirements.
“Under-35s tend not to have a mortgage, car finance or a credit card,” he explains. “They have not lived in the same place for three years. That doesn’t make them a bad risk – we just analyse the data in a new way.”
Costs are kept low by a fully-automated loan process that engages with customers in their preferred manner. “We give a yes or no in seven seconds, and if it’s yes then the money is delivered electronically,” says Graham. “It’s about delivering the product in the way they want. On their mobiles, and without talking to anyone unless they actually want to.”
So consumer lending may have slipped out of the spotlight to some extent lately, but for investors there are still plenty of reasons to be cheerful, and plenty of options for their investment portfolios.
“We have just signed off on our business plan for the coming financial year, and it basically says that we are determined to keep doing what we are doing, and keep growing,” says RateSetter’s Behrens.
“There is a feeling that the world is a little less settled than it was three years ago, so I think that sticking to your knitting and trying to chart a sensible course is probably no bad thing.”
This article featured in the May issue of Peer2Peer Finance News, now available to read online.