First they disrupted the market, then they were regulated, and now they have the IFISA. It’s time for the peer-to-peer lending sector to embark on the next stage of its journey…
May you be cursed to live in interesting times goes the old Chinese proverb, a timely warning that periods of rapid change may take us to exciting new places but also often involve a pretty bumpy ride along the way. And while not many in the peer-to-peer lending sector would regard themselves or their industry as cursed – rather the opposite in fact – there can be no doubt that the times are interesting, and about to get a whole lot more so.
Thanks to ever-smarter tech, new products like the Innovative Finance ISA (IFISA), new funding models, economic uncertainty and the blurring of the lines between traditional banking, P2P lending and the wider alternative finance community, there are a whole bunch of powerful and unpredictable influences coming to bear on the P2P sector over the next year or two. Just how mainstream can P2P get, without losing sight of the reforming zeal that brought it to life in the first place?
Perhaps the biggest current opportunity for a step change in the way that punters – and the market – regard P2P is the much-vaunted IFISA. The tax-free wrapper has been heralded as the product that will see P2P break away from its DIY investing roots, attracting a whole new raft of customers whose most sophisticated financial purchase until now has been a savings account.
As our IFISA special report in our November issue shows, the potential impact of this product on the P2P industry is immense and yet to be fully realised.
However, a big question hanging over the future, not only of P2P but the entire financial services industry, is the prospect of a serious economic slowdown for the first time in almost a decade.
As P2P sceptics everywhere never lose a chance to point out, the sector as a whole has never been tested by a serious recession. Consequently there are some platforms which are ill-prepared for stormy weather, says Stephen Findlay, founder and chief executive of BondMason.
“P2P hasn’t been through a credit cycle yet, and some of them are struggling even in relatively benign conditions,” he comments. “If people are making loans where 25 per cent are in default already – which some are – then all you can say is that they don’t know what they are doing. But if they have been diligent and cautious and have robust credit assessment and scoring, they will probably be OK.”
Read more: Is the P2P sector prepared for a downturn?
Even if some platforms do fail, anyone expecting a bank-collapse style spectacle will be disappointed, according to Neil Faulkner, managing director of independent P2P analysis firm 4th Way.
“P2P failures will be much less dramatic than bank failures,” he argues. “P2P lenders are not allowed to use your money for anything else, it is not part of the assets of the platform. There is no leverage and no ridiculously complicated products. It’s way, way safer than banks.”
So whatever the doom mongers might say, a P2P bloodbath is far from a foregone conclusion. In fact it’s perfectly possible that it will weather a recession rather better than some more traditional asset classes.
“There is always lots of negative comment about the fact that P2P has never been through a recession,” says Peter Renton, founder of the LendIt conference series. “Once we have, people will see that their P2P portfolio has only gone from six per cent to, say, two per cent returns – that’s a big drop of course but still positive.”
It might also inject a dose of realism into some of the Panglossian predictions that have dogged growth projections and company valuations in the past few years.
“There are good markets and profitable business to be done, but probably not at the growth rates that were assumed initially,” says Andy Davis, author of a pair of influential reports on P2P for the Centre for the Study of Financial Innovation. “It’s a hard slog and it takes a long time to get to scale.”
But consumer lenders may be more vulnerable than those in the SME space, he adds. “I suspect that consumer credit conditions will worsen. That market will become challenging for small players. The small business end of the market is inherently more diverse and there are more funding structures.”
Davis argues that in the future, larger P2P platforms will shift towards hybrid models, embarking on balance sheet lending like banks to increase their profitability, although this hypothesis is fiercely contested by some industry figures.
“Banks enjoy extremely cheap funding, if you are trying to compete with a bank and your cost of funding is significantly higher then you are not in the game,” he adds.
To P2P purists, balance sheet lending can look like heresy – the antithesis of what the sector is supposed to be about. But heresy or not, it is inevitable, says LendIt’s Renton – just look at the US market.
“As companies scale, the marketplace model becomes challenging. No-one in the US now is totally committed to the pure marketplace model. I don’t quite understand the commitment to it [the platform model] in the UK. It’s almost religious.
“But you have to be pragmatic – the bottom line is that borrowers are going to be loyal to the best rates, rather than to a particular platform. And a bank’s cost of capital means lower rates.”
Not everyone agrees. Funding Circle is one high-profile dissenter from the hybrid orthodoxy.
RateSetter is another, as head of policy John Battersby explains. “We have a very clear position on this – from the start our focus has been on retail money,” he says.
“So hybrids are not for us. We think there is a big appetite for self-directed investment – one million people will be investing in SIPPS for example. We designed our model with the retail investor in mind right from the start.”
Read more: Platforms develop their own SIPPs
So P2P is being stretched into a new shape by the pull to attract a new breed of mainstream customer, and a shift to more flexible funding models to better service the anticipated demand.
That new shape will inevitably see it losing some of the distinct, DIY identity that made its name in the first place, says BondMason’s Findlay.
“P2P will be integrated into the wider community, it won’t go mainstream in its current form,” he argues. “There will be lots of wrappers to make it simpler for investors.”
So with all that coming down the pipe, perhaps it’s not surprising that the industry’s equity investors are starting to ask that question they always do in the end – when will their P2P investments start to show a profit?
In the US the mood music is changing, says LendIt’s Renton. Having bankrolled growth for some years now, many backers there are starting to press for returns.
“In general, returns to shareholders have not been great,” he explains. “Lending Club is still only at a quarter of its high, OnDeck is even lower.
“What’s changed in the US is that the only ones getting funded in 2017 are those with a pathway to positive cashflow – and not too long a one at that.”
The same tune is likely to start playing shortly on this side of the pond. P2P may be about to enter the equivalent of its difficult teenage years, but the journey is worth it.
Even in the most interesting of times.
This news story featured in the November edition of Peer2Peer Finance News – now available to read online!