Institutions were playing an increasingly large role in the peer-to-peer lending sector, and then Covid-19 hit. Michael Lloyd explores the changing role of City funding in P2P…
Peer-to-peer lending platforms have historically sought institutional investment as a means of scaling up quickly, while institutions have used the platforms to diversify their own portfolios. But in the midst of a global pandemic and a deep economic recession, some institutions are showing caution, meaning that P2P lenders who expected to secure more funding lines this year may be disappointed.
Some institutional funds are still available, but others have opted to take a step back while reviewing the market. According to Carl Davies, chief operating officer at The House Crowd, some of the institutions he and his colleagues have been in discussions with are aggressively prowling the market looking for “distressed” opportunities, while others are sitting on the side-lines appraising the opportunities in a more considered way.
“I think generally they are all cautiously optimistic, but I don’t think we will see a feeding frenzy,” Davies comments. “Most will appraise the situation from now until the end of 2020. Then in the New Year, depending on how the market reacts to the easing of the lockdown, we may see significant activity.”
Outside of P2P, many traditional property development lenders have been forced to tighten their lending heavily or to stop lending entirely, due to a contraction in institutional funding. This created a funding gap for small- and medium-sized enterprise (SME) property developers – many of whom then turned to alternative lenders to seek funding from the crowd.
“Institutions are cautious, but this could be an opportunity for P2P,” says Atuksha Poonwassie, managing director of Simple Crowdfunding. “It’s why there are more SME developers going to P2P and crowdfunding platforms.”
Varengold Bank, which backs some P2P lending platforms, is still focused on helping alternative and fintech lenders, including those operating a P2P model.
“[The pandemic] has of course resulted in a reduced capacity for new originations, but we continue to have appetite to make new investments,” says Alison Harwood, chartered alternative investment analyst and head of the London branch at Varengold Bank.
“Of course, where new investments are focused, it has been affected by the pandemic and the government-backed loan schemes have been interesting to us in a dynamic credit environment.”
Despite the short-term caution, the consensus view appears to be that Covid-19 will lead to more institutional interest in P2P.
Institutions will notice the platforms that have performed well during the crisis, onlookers suggest, riding out the storm by offering attractive returns whilst mitigating their risks, and demonstrating robust internal systems when fighting the inevitable rise in defaults.
“As the sector gets through this economic downturn, the well managed platforms will pull through and institutions will see how they performed during the crisis and become more familiar and interested in P2P,” says Daniel Rajkumar, managing director of Rebuildingsociety.
“So far, compared to other markets, P2P has done well, performing better than the stock market, which took a tumble, and cash savings, which offer low returns.”
The P2P sector has also benefitted from the introduction of government-backed emergency loan schemes such as the coronavirus business interruption loan scheme (CBILS). A handful of P2P lending platforms have already been accredited to deliver CBILS, including Funding Circle, Assetz Capital, Folk2Folk and LendingCrowd. Under the rules, only institutions can fund CBILS loans.
For institutional investors, accredited P2P platforms offer a great opportunity to access government-backed loans during a period of economic uncertainty. However, this also means that the value of having friendly institutional partners has become even more pronounced for P2P lending platforms. Peer2Peer Finance News knows of several platforms that are working hard to try and obtain the institutional relationships they need in order to qualify for accreditation.
Funding Circle’s UK managing director Lisa Jacobs recently told Peer2Peer Finance News that it was its existing relationships that were first to step up to fund its CBILS loans. “We’ve re-engaged with our existing investors or investors who we were already in conversation with, so we’ve built on relationships that we’d had before,” she said. “These are investors that have already done due diligence on our product to date and had been close to or were already lending through the platform.”
However, Jacobs added that there are also new institutional investors that Funding Circle has not had a relationship with before, who are now expressing interest in funding its CBILS loans. This suggests that the government’s emergency loan schemes could have a positive effect on the wider industry, by boosting institutions’ awareness of the benefits of P2P.
CBILS-accredited rural business lender Folk2Folk says that the platform hasn’t seen a decline in investing appetite from its existing institutional lenders during the pandemic, while Simple Crowdfunding’s Poonwassie affirms that institutions are becoming more interested in P2P as a direct result of the government lending schemes. However, it should be noted that the government only guarantees CBILS loans up to 80 per cent of their value, meaning that the lender still has some exposure, albeit diminished, and must take the first loss on defaulted loans.
Some analysts have suggested that more than half of these government-backed loans could result in a default, distorting the marketplace and testing the resilience of P2P lending platforms – and their backers. According to Varengold Bank’s Harwood, feedback from the industry seems to indicate that the government underwriting of loans has not been sufficient to draw as much investment into the industry as would be needed to meet borrower demand.
“My own perspective on why this has been the case is that the number of experienced institutional investors able to confidently quantify and price risks associated with P2P originated loans outside of the credit risk of the relevant portfolio is limited, and the environment is too uncertain for new players to enter confidently,” she says.
Before Covid-19 arrived, there was a noticeable rise in the number of institutional investors paying attention to the P2P sector. More and more P2P platforms revealed that they had secured City funding lines, including Assetz Capital and Relendex, allowing them to scale up their lending more quickly.
Furthermore, partnerships between banks and P2P lending platforms have also been growing in popularity – Funding Circle had a pre-Covid referral arrangement with Santander, while Zopa announced a partnership with Metro Bank way back in 2015.
And in the Covid era, we have now seen a partnership between Starling Bank and Funding Circle. By the end of July, the challenger bank had lent £227.75m to small businesses via Funding Circle, as part of a £300m CBILS funding agreement. Nic Conner, research consultant for business finance experts Rangewell, predicts that there will be many more deals between neo-banks and platform lenders going forward.
“As such banks start to ramp up their in-house lending (to efficiently use the funds they have on deposit), they will look to P2P partners with proven origination and credit models,” he says. “Institutional funds, as well as other lender pools, see significant opportunities in SME lending over the next five years.”
Another huge deal was announced in August of this year, when Metro Bank acquired RateSetter. This suggests that there is increasing interest in the sector from banks that are seeking to expand their lending. “P2P lending platforms are definitely in the spotlight and attracting a lot of interest as a possible source of high return, high volume investment opportunities,” says Davies.
As fintech pioneers, P2P lending platforms are always innovating, and new technology is making it as easy as possible for institutional investors to dip their toes into the sector. When blockchain-based secondary market platform ASMX launches, it will offer greater liquidity for institutional investors, and platforms will be incentivised to adhere to the standardisation of the secondary market, by filing their paperwork and structuring loans in the same way.
David Bradley-Ward, chief executive of ASMX and P2P lender Ablrate, says smaller platforms that lend about £10m to £15m a month will then be able to gain access to institutional capital through the standardisation of the secondary market platform. “It’s the standardisation of platforms that will allow aggregation of platform loans,” he says. “I guarantee platforms will change their legal structures to get their hands on institutional money.”
The promise of ongoing innovation, as well as the mainstreaming of P2P lending through government-backed loan schemes and bank partnerships, should inspire more institutions to back P2P loans. The question is whether this will be at the expense of retail. As they have scaled up their institutional funding, some platforms have opted to stop retail investment entirely. Both ThinCats and Landbay exited the retail space in favour of institutional investors in December last year, and both cited the fact that it’s difficult to scale via retail lenders only.
Although more platforms could exit from P2P, platforms and analysts tend to agree that retail has a future. After all, some of the largest platforms still successfully combine institutional and retail investments. And the binary nature of institutional funding – which has come into focus as the credit cycle turns – should further bolster the case for the diversification of retail money.
“We’re open for retail business, definitely want retail lenders and won’t leave retail investment,” says Stuart Law, chief executive of Assetz Capital.
“A lot of savvy retail investors will carry on with this part of their portfolio for a long time.”
Read more: Assetz offers ‘home’ for RateSetter lenders
Most industry stakeholders agree that the future of the industry will see both institutional and retail investors playing a role. Despite their caution, more and more institutional investors are waking up to the benefits of P2P lending as a dynamic part of their portfolio. And as more and more P2P lending platforms prove their worth by delivering stable returns amid a recession of historic proportions, that caution will surely soon give way to confidence.