Neil Faulkner, chief executive and head of research at 4th Way, tells Marc Shoffman what goes into analysing a P2P lender
P2P lending has become a multibillion-pound industry and as the sector has grown, so too has the need for independent analysis. At the forefront of industry commentary is 4th Way.
It was set up in 2014 by Neil Faulkner (pictured) who was previously a spokesperson for stock analysis website Motley Fool.
The former financial journalist and stock analyst has adapted the Motley Fool’s style to P2P. He has built a team of researchers that provide regular Plus Ratings to assess the risk and returns on offer from a platform as well as summaries of the main players in the UK’s P2P lending space to help investors choose where to put their money. He explains what goes into analysing a P2P lender.
Mark Shoffman: How do you assess a P2P lending platform?
Neil Faulkner: It was obvious when it started that P2P lending was a good idea. It was the first new good idea in investing I had seen in 20 years. Our full initial due diligence process takes two to four weeks, it is very intensive.
It is an incredibly detailed process. We look at more than 100 different data points and there are lots of email questions and face-to-face meetings. Our main focus is risk. We look at how good a platform is at underwriting, how good is its book of loans, will borrowers repay and what are the chances of recovery.
A large chunk of the information we collect is from a survey we send to platforms and the rest is looking at the experience of the people behind a platform, how the loans are secured and a brief summary of their results.
Platforms are also asked to provide their loanbooks regularly, usually once a month or every two months to keep track of what is going on. This makes it harder to hide important problems that may be impacting the business.
We are looking constantly at what would happen to lenders if there was a banking crisis and have developed our own stress testing models. There is also a consideration of returns on offer and the platform risk such as how much could be recovered in a wind-down.
A lot of investors are keen to get their money back but money lending isn’t designed to always enable that. P2P lending works well most of the time but investors have to understand that you can either have stable returns or liquidity, you can’t have a high guarantee of both.
MS: Zopa recently lost its 4th Way Plus ratings, have other platforms lost their scores?
NF: This is the first time Zopa has lost its ratings. It used to provide updated data regularly, but it’s just been too patchy for the past 12 months. It’s not that it doesn’t provide enough data, just that it doesn’t provide it regularly enough. It makes it a bit easier to hide problems if you don’t provide data routinely.
I absolutely don’t expect that Zopa is hiding problems, and it’s probably harder for Zopa to do so than other platforms, but the rating rules have to be applied fairly and equally across all platforms.
RateSetter is no longer rated as it is moving away from P2P lending.
Funding Circle lost its ratings in mid-2018 when it stopped providing regular data to 4th Way on its performance after it became a publicly listed company.
Platforms are more than happy to provide regular data. Regular submissions are needed to assess loanbooks and spot anomalies. When there is a new platform or if a lender wants more coverage, we expect to see their loanbook.
MS: Have you managed to save investors from P2P lending platform failures?
NF: Generally, when platforms become less transparent, our rule is not to invest. We had hardly any contact with the platforms that have fallen from grace as they weren’t transparent. That should have been enough of a sign for investors as we weren’t covering these platforms. If they aren’t providing information you can’t say how good they are.
MS: Why is analysis of the P2P sector needed?
NF: We get a few comments from people who wish they had found us earlier. Focusing on the lenders we cover on 4th Way would have saved a lot of disappointed investors with FundingSecure, Lendy and Collateral. Choosing a P2P lender is easier than choosing a stock but there is still a lot to think about. You have to do your own due diligence. Analysts are important as we get a level of access no-one else does.
It is also important to understand what you are doing though. For example, you could take an external analyst’s view and invest, but then if there is a recession you have to understand why it may be better to keep your money in rather than panicking and withdrawing your funds.
MS: Have Financial Conduct Authority (FCA) regulations made it easier to assess P2P lenders?
NF: There has been a minimal impact from the new regulations in terms of transparency. The appropriateness tests force investors to read what they are doing before they sign up but the regulations don’t focus on working out if P2P is a good investment.
That’s not the job of the FCA. It just has to make sure the product is clear.
MS: Why do you think the regulator and the mainstream press see P2P lending as so risky?
NF: There is a level of caution in the press that is totally understandable. It is the job of the press to be sceptical. P2P lending is reasonably new so if everything works then it is business as usual but as soon as one platform collapses the FCA will face questions about why it wasn’t on top of it.
As the years go by people will look at the returns and more will believe the sector is big enough to have a respectable track record. The industry could do a lot more to promote the benefits though.
They do a lot of marketing for themselves but could do more to say look at the results of this industry since 2005. All these platforms could present data showing it’s a stable way to make money and demonstrate a track record to the FCA and investors.
MS: What are the biggest challenges for the sector?
NF: It depends on the platform. It will be very individual. Some will struggle with revenue or bad debts for a bit. For the most part it will continue to tick along reasonably. There does needs to be more education about risk reward balance. I think closures will happen and there are likely to be acquisitions rather than mergers.
MS: What are 4th Way’s plans for the future?
NF: We know millions of pounds can enter or leave a platform based on a research report by 4th Way. The core way we have made money has been through affiliate commissions for platforms that want extra coverage. Our next step is to launch a subscription service for investors.
Information should stay free in the vast majority of cases. People tend to want shorter summaries and reviews but there are those who want greater detail. The subscription service will publish a lot of the due diligence we do such as the background notes and transcripts of meetings. 4th Way also provides credit modelling for platforms and we will continue to do that.