What are institutional investors looking for in the peer-to-peer lending sector?
It is no secret that institutional investment has been growing in the peer-to-peer lending sector. But post- Covid, institutions are armed with financial firepower and alternative lenders are in their sights.
Earlier this year, CrowdProperty announced a £300m institutional funding line from an unnamed “major investment manager” to support its P2P property loans.
Meanwhile, Fasanara Capital has previously invested in UK P2P platforms including FundOurselves, and Varengold Bank has pumped funds into EstateGuru and Assetz Capital.
Furthermore, Starling Bank has revealed that the vast majority of its coronavirus business interruption loan scheme (CBILS) funding has gone to small firms via its Funding Circle partnership.
Alison Harwood, head of the London branch of Varengold Bank, says the funder is actively growing its investment portfolio of wholesale loans to non-bank lenders, both across the P2P sector and to balance sheet originators.
“We are currently seeing more non-bank lenders launch under a balance sheet lending model, rather than under a P2P model,” she says.
“Consequently, early-stage P2P investment opportunities are lesser in volume. They have some disadvantages to a balance sheet model, such as due diligence and understanding compliance risk associated with P2P regulation. This does not however preclude them from investment for us.”
John Cronin, an analyst at Goodbody, says there seems to be a greater level of confidence in the P2P sector specifically.
“The landscape for institutional funding more broadly is quite positive,” he says.
“Since the depth of the Covid crisis it is certainly picking up and institutions are showing a greater level of interest in P2P specifically.”
So what are these institutions actually looking for?
Platforms typically report that institutions are keen to examine their team, their experience and their procedures. They also want to see a strong track record of lending growth and a quality-focused credit engine, as well as clear plans on how the P2P lender will use the funds allocated.
“Team, experience and track record are the key elements for the initial review,” says David Jelly, chief executive at Property Bridges.
“After an initial review, six months of thorough due diligence will follow in which every document, process and system will be scrutinised.”
Harwood says Varengold carries out a comprehensive due diligence process covering all aspects of the platform’s business and operations, alongside in-depth financial analysis.
“We work principally with early-stage originators, looking to identify platforms with good ideas in need of institutional financing to help support their early years portfolio growth,” she says.
“We want to see a product offering with credible growth prospects, coupled with robust operations able to scale alongside that growth.”
Harwood goes on to say that provided loans are priced properly according to risk, Varengold is agnostic as to loan type.
“We do not however support lending which does not fulfil our sustainability criteria, such as pay-day lending,” she adds.
As well as thorough due diligence, institutions have their own terms that platforms need to consider and these may deter some from accepting their money.
Neil Faulkner, managing director at P2P ratings and research firm 4thWay, says that institutions typically have very specific requirements in terms of the types of loans they are willing to lend in.
“For example, they might want to lend in one type of property loan to a maximum loan-to-value of 70 per cent,” he says.
“They also want to see that they will be able to deploy enough capital. Aside from that, they look for what any good analyst looks for: the right people, processes and past record, as well as the appropriate legal and regulatory structures.”
Faulkner goes on to say that some institutions also only lend through platforms that have a 4thWay PLUS Rating and some have other wishes or requirements, such as needing to lend through a securitisation or wanting to be the initial underwriter of loans.
Filip Karadaghi, co-founder and chief executive of LandlordInvest, says it is “very simple” to find institutional capital, but the problem is the terms that must be agreed on.
He says every funding provider has very different terms, banks have certain costs associated with due diligence and legal costs, monitoring costs and various other things and if a platform has not delivered all of the institution’s funds, they can face a penalty fee on what they have not deployed.
“Once you engage with the providers, it’s down to you to decide which is best to reflect funding arrangements; everyone has different costs and fees,” Karadaghi says.
“I know a lot of platforms make noise about raising funds, but it’s not that difficult. There’s a lot of money out there if you have the ability to meet the criteria.
“It depends on the fees you have to pay and if they are reasonable, we have no rush to jump into expensive funding lines. Institutional funding is very easy to maintain, and we will do it on terms we think are suitable for us.
“Many that receive funding offers do not have the same experience and background and will jump at them much more quickly and are prepared to discount the high cost to get that funding.”
There are broadly two types of institutional funding lines, committed and uncommitted facilities.
A committed facility means the institution will pick a certain subject loan criteria and take all the loans automatically, simply purchasing them from the platform without checking them on a loan-by-loan basis, whereas an uncommitted credit line is where the funder reviews and checks every loan.
Uncommitted offers are easier to attract when a platform has a lack of a track record.
Peer2Peer Finance News understands that one platform even went so far as to decline a committed offer in April of this year. This demonstrates that there is capital available, but it may come with a few strings attached.
Some other platforms have chosen never to take on institutional capital for various reasons. Crowdstacker says that it aims to connect retail investors – and only retail investors – to businesses, while JustUs chief executive Lee Birkett says that it refuses to give institutions better deals than retail investors.
Birkett says that he has spoken to institutions but refuses to give “special deals to institutions that goes against the whole ethical methodology of P2P”.
“We give the same deal for someone putting in £100 as someone investing a million, whereas institutions want a special deal,” he says.
“That’s how they operate. The restrictions institutions put on you removes the DNA of P2P. It’s not something we’d choose to do. Some institutions want preferential terms and want the platforms to take a balance sheet risk – most want you to take the first loss.”
There is a common belief that platforms need to be of a certain size in order to attract institutional capital, however others dispute this as a misconception.
“It’s the wrong assumption, it’s not true,” says LandlordInvest’s Karadaghi.
“For a bridging lender that’s very small and starting out to get funding, that’s how they get it. There’s a misconception you have to be bigger, but anyone can go and get a funding line from day one without a loanbook established.”
4thWay’s Faulkner agrees and says that it is not especially difficult for platforms to attract institutional money with many having done so already.
He says they just need to pass an institution’s due diligence and demonstrate that they can bring enough quality borrowers in to make it worth the institution’s while.
“Platforms have managed to get institutional funding even while lending in the low tens of millions per year, so it is certainly open to smaller platforms,” Faulkner says.
“There are a lot of smaller institutions too.”
However, Property Bridge’s Jelly highlights that while it is possible for smaller platforms to attract institutional capital, it is more difficult to do so at that size.
“We’d consider ourselves relatively small and we have managed to attract institutional investment, so it is possible, but it’s not easy,” he says.
“All institutional investors will require platforms to have the necessary operational and regulatory systems in place as well as the personnel capacity to originate and manage a loanbook. This can be a resource challenge for some of the smaller platforms.”
Institutions are taking notice of P2P lending platforms, approaching them with offers and pumping more and more money into the sector.
Many platforms take this route to scale up, and some have even left the retail space to focus solely on institutional backing. However, there is no such thing as free money, and while there may be a glut of institutional money in the P2P space right now, it often comes with a few conditions. It is worth highlighting the detailed due diligence that institutions undertake, the experience and track record and management of the platforms they analyse closely, as well as the terms and conditions that they impose.
If platforms are after institutional funds, they do not just need to attract it, they need to negotiate for it and only accept suitable offers.