Consumer lending is the essence of peer-to-peer finance, but low interest rates and warnings of a debt bubble have taken the gloss off the sector. Can personal loan-focused platforms continue to thrive in the current climate?
In the peer-to-peer industry, business lending is what everyone seems to be talking about these days. Platforms offering finance to small- and medium-sized enterprises (SMEs) and property developers, such as MarketInvoice, Lendy and Assetz Capital, are enjoying some of the highest growth rates at present. Even RateSetter, which had mainly focused on consumer finance, recently revealed plans to ramp up its business lending.
SME finance has acquired a new shine in the Brexit era, as businesses across the country seem strongly determined to turn uncertainty into an opportunity for growth.
And P2P firms look increasingly eager to volunteer as the supporters of these ordinary SME heroes, stepping in to fill the funding gap created by traditional lenders that are once again in the process of retrenching and tightening their lending.
Measured against this promising SME bonanza, the consumer space could seem less attractive. To use the unforgiving words of Metro Bank’s chief executive Craig Donaldson: “At rates of 2.7 per cent to 2.8 per cent, unsecured consumer lending just doesn’t any make economic sense for us”.
The boss of the challenger bank revealed that the firm, which had partnered with P2P consumer champion Zopa in 2015 to increase its lending in that space, is now steering well clear of unsecured consumer finance.
“We are just not willing to lend at those rates,” he explains. “The risk/return dynamic is just not right at the moment.”
A 90 per cent loan-to-value secured mortgage produces a higher yield and requires less capital, he points out.
It appears that the days when everyone wanted a slice of the consumer cake are now over, dissolved in time by protracted ultra-low interest rates and renewed cautiousness.
“With consumer loans available for 2.8 per cent on comparison websites and mortgages available for only around one per cent, competition is harsh and profitability is decimated,” says Kevin Allen, chief risk officer of The Money Platform and a veteran P2P investor.
Allen, who was RateSetter’s first chief risk officer, recollects that one of his first P2P investments was lending to a consumer who wanted to consolidate existing debts.
“My share was £20 at an annual percentage rate of 8.3 per cent,” he says.
“Those were fun days; on some of the P2P platforms you got to see a picture of the borrower and a description of what they wanted the money for. But those days are gone.”
Now, consumer lenders Zopa and RateSetter return around three to four per cent to investors, which is dwarfed by the seven to 10 per cent returns typically yielded from SME lending and around 12 per cent on most property platforms.
Data from the Peer-to-Peer Finance Association shows that in less than a year, its members have reduced their new lending volumes to individuals against businesses by about 18 per cent, going from a 6.2 to 10 ratio in the second quarter of 2016 to a 5.1 to 10 ratio in the first quarter this year.
And if this weren’t enough to strike a tough blow to the appeal of consumer debt, recent data and warnings by policymakers have added to its reputational decline.
In March, the Bank of England’s Financial Policy Committee stepped up warnings about households’ over-indebtedness against a backdrop of stagnant wages and rising inflation, as consumer borrowing returned to historical highs.
Interest-free offers on credit cards and an increase in loan limits are contributing to the fastest rate of expansion in consumer credit since 2005, the committee warned, announcing it would increase its scrutiny in that space.
This compounded a parallel review by the Financial Conduct Authority (FCA) on creditworthiness assessments used in the consumer credit market, and a separate investigation by the Prudential Regulation Authority into new lending across credit cards, personal loans and car dealership finance.
While these headlines could sound like bells of doom for consumer borrowing, to more attentive eyes and ears they could conceal precious opportunities.
It would not necessarily be wise to turn away from what has been the bread and butter of the P2P industry to chase newer and easier sources of profit.
“When there’s a squeeze on one sector, naturally people start taking more risks and going into unchartered territories that generate volumes rather than being sustainable, but it is not all as risk free as it looks,” warns Abhai Rajguru, co-founder and chief financial officer of online consumer lender Nava.
Despite the concerns of regulators and policymakers, there are still opportunities for P2P consumer lenders.
Bank of England data shows that banks and building societies charged an average interest rate of 6.9 per cent on new personal loans at the end of 2016.
THis is “vastly at odds with the rate prominently advertised on their websites, which is currently standing at almost half that level, at 3.5 per cent [on average],” according to Rajguru.
Such a discrepancy could benefit the P2P sector, which prides itself on its unparalleled transparency. And with banks sometimes offering higher interest rates than their websites suggest, a P2P consumer loan could be more competitive on price as well.
Furthermore, Anthony Parry, senior vice president at Moody’s, says that while rising household indebtedness in the UK has received a lot of attention recently, P2P firms fall outside the category of lenders that have prompted regulatory scepticism.
“Clearly, P2P lending remains a relatively small part of the overall consumer loan market in the UK so is not itself fuelling this growth,” he comments.
Michael Todt, spokesperson at consumer finance platform Lending Works, affirms that P2P players have so far not contributed to unsustainable levels of household debt.
“Any evidence of a credit bubble is not a reflection on consumer P2P lending,” he says.
“Our rigorous underwriting standards and affordability checks and our ongoing vigilance with respect to arrears and defaults, coupled with the fact that our credit models are stress tested against data from recessions in 2009 and 2011, leave us confident that our customers will fare well throughout the cycle.”
The UK’s oldest P2P lender Zopa, which launched in 2005, proudly proclaims that it has survived through a downturn in the credit cycle. Allen points out that the platform managed to protect 100 per cent of its lenders’ capital through the crisis, although it should be noted that Zopa was in its nascence at the time with a comparatively diminutive loan book.
Despite the challenges, P2P platforms are now presented with a golden chance to offer consumers a better and fairer service than both high-street banks and expensive payday lenders.
There is a potential borrower pool of about one quarter of the country’s adult population, or 14 million people, that are “imperfect borrowers” in the eyes of the traditional banks and building societies, points out Rajguru.
And according to data collected by Nava, one third of households are shunning the possibility of applying for credit as they see it as a perilous path following the financial crisis.
But Parry says that borrowers are not currently facing any particular risks.
“For the wider market we believe consumers will continue to be able to service their unsecured debt levels,” he explains.
“Most importantly, due to the ongoing low interest-rate environment, but also [because] regulators have taken positive steps to address overall consumer debt levels ahead of any issues emerging.”
Increased regulatory scrutiny and requirements may actually help catalyse the innovation that the P2P consumer market needs to prosper, Allen suggests.
“Regulatory requirements to perform enhanced credit assessment will not necessarily mean more ‘no’s or slower application processing, but will quicken innovation, as well as potentially improve the quality of credit decisions,” he says.
Rajguru thinks that platforms should focus on boosting their ability to price risk correctly, which would then allow them to make their way into new consumer credit niches that could prove highly successful.
“There is a case for a more sophisticated and intelligent analytics approach to loan applications, that looks beyond credit scores and considers the specifics of the individuals involved,” he comments.
Current issues in the consumer credit space could thus become a bridge to better business practice, innovation and expansion into new sub-segments and areas of unrealised growth, rather than lead to an inescapable and infertile crisis.
“Consumer lending is a huge market,” says a spokesperson at RateSetter, “and although P2P lenders such as ours have grown, there is clearly still more opportunity in the market.”
More opportunity to disrupt and innovate a poorly-serviced market, for which P2P players would once again have to thank traditional lenders.