2020 is turning out to be a make-or-break year for peer-to-peer (P2P) lending. In my original article about P2P, I wrote:
There are currently somewhere around 70 peer-to-peer platforms in the UK, and a sizeable chunk of those won’t make it through the next downturn.
Then in January 2020, before COVID-19 was on my radar or almost anyone else's, I wrote in a blog post:
I’m long-term positive about the sector, but under no illusions: every sector goes through a messy shake-out on its way to maturity, and this will be no different.
Well, that downturn is here and that shake-out is underway. I wasn’t expecting it to happen this year, but it is – so where does that leave investors in this asset class?
I’ve delayed writing this update because the eventual outcome is still far from clear. By now though, we’ve seen enough from how various P2P platforms are being affected and are responding to get some clues about how things might pan out.
We’ve seen P2P platforms affected in two important ways: the impact on the loans themselves, and the response of the investors in those loans.
Obviously, you’d expect COVID-19 and the lockdown measures to affect the actual loans that investors are funding:
To what extent have these loans been affected? It’s too early to say with any certainty: lenders have been showing forbearance so we don’t fully know how many interest payments will end up being missed, and it’s not until near the end of loan terms that we’ll know whether they’ll be repaid on time (or at all).
While it’ll take more time to draw conclusions about the loans, the effect on investors’ behaviour became clear almost immediately…
As I also wrote in my original article:
However, like all markets, peer-to-peer is all about confidence. If there’s a general loss of confidence in the economy or a specific loss of confidence in a particular platform, everyone could want their money back all at the same time – just like a run on a bank. If that happens, there could be lots of loans being sold and none being bought – meaning that you can’t get your cash out.
Well, “loss of confidence in the economy” would be putting the sentiment of April 2020 mildly. I’ve never experienced anything like it: everyone suddenly fearful not just for their jobs and their businesses, but their health as well. Watching the queues outside Northern Rock 13 years ago doesn’t even come close.
Understandably, there was a sudden rush for cash across all asset classes. Even supposedly “defensive” assets like Gold fell for the first couple of panicky weeks, as everyone indiscriminately sold everything.
P2P was no exception. There was a huge rush to pull funds from the platforms, with likely reasons being:
This is very similar to your classic bank run: everyone gets spooked and wants their money at the time, only to discover that the bank hasn’t been holding anywhere near enough to pay everyone back at the same time.
P2P platforms never claimed they were set up to give instant access to everyone at the same time. Where liquidity is offered, it’s always caveated with “under normal market conditions”: in other words, you can only get out if someone else wants to come in to take your place.
Normally that’s the case, but all of a sudden it very much wasn’t. And despite the caveat, for the situation to reverse so quickly and leave investors “trapped” came as a shock to many.
It’s been interesting to watch how different P2P platforms have responded, and which have been affected more than others. I’ve been keeping the closest eyes on those I have money with (obviously), so I can share a bit of my understanding of how they’re coping.
Ratesetter has always operated a “provision fund” which it sets aside to pay investors back if borrowers default. It forecasts its likely amount of bad loans, and increases or decreases the size of the provision fund accordingly.
Clearly, events this year mean more loans are likely to go bad. The majority of Ratesetter’s loans are unsecured consumer loans, so more people might struggle to pay them back if they lose their job, and if they do there’s no asset for Ratesetter to repossess to get paid back.
As a result, Ratesetter decided to halve its interest rates to investors – with the other half going straight into the Provision Fund to boost it. It currently projects that this will be enough to avoid investors suffering any capital losses, although it’s impossible at the moment to know if that’s the case.
(You could argue, if you're feeling uncharitable, that capital preservation with a loss of expected interest because it's been diverted into a Provision Fund is just a way of dressing up what would otherwise have been a small amount of capital loss with interest.)
At the moment the measures they’ve taken seem to be holding up, but it’s impossible to say for sure.
When it comes to withdrawals, Ratesetter has suffered from the general rush to withdraw that I mentioned earlier. It’s operating a queueing system where withdrawal requests are paid out in order as the funds from repaid loans come in. As far as I understand it, this means that if someone in position #1 has put in a request for £10m (to give an extreme example), the person in positions #2 onwards will be held up potentially for weeks while Ratesetter releases the full £10m to the first person. This is a different system from the one Assetz Capital has implemented, as we'll see shortly.
Separate from all this, Ratesetter was bought by Metro Bank in July 2020. This represents a terrible outcome for the backers of Ratesetter as a company, but I see it as good news for P2P lenders because it reduces (to close to zero) the risk of the platform failing.
Assetz has similarly struggled with a sudden rush of withdrawals – especially from its Quick Access Account. This account promises near instant withdrawals “under normal market conditions”, but those conditions don’t exist any more.
To deal with the backlog of investors wanting funds out, Assetz has introduced a different queueing system from Ratesetter. Instead of everyone having their place in the queue then getting paid out in full when they reach the front, everyone in the queue gets paid out “pro rata” whenever funds come in. For example, if a £1m loan repaid and there were 10,000 investors in the queue, every investor would be allocated an equal £100 of the repayment.
You could see this system as good or bad. It’s probably disadvantaged people who were quick to get their request in and would otherwise have been at the front of the queue, but means everyone will get a steady drip over time. It probably also disadvantages people requesting large amounts, who might be waiting a very long time for the regular drip to pay them out completely.
To placate investors who want to get their money out more quickly, Assetz has introduced a marketplace where investors can choose to offer a discount on their holdings to entice someone else to buy them. For example, if I had £10,000 invested and I wanted it out, rather than waiting for the £10,000 to repay naturally I could offer a 5% discount. This might be enough to tempt another investor to pay me £9,500, meaning they tie up their money in the expectation of eventually making a £500 gain on top of the normal interest (assuming they don’t believe there will be any capital losses).
Over the couple of weeks since the marketplace was introduced, the discount has hovered around 5-6%.
Another controversial move by Assetz has been introducing a fee for investors which will be deducted from the interest earned. This is especially controversial because if you don’t like it, the queue means you can’t immediately take your money out and leave.
The fee was introduced to bolster Assetz’ revenues, because they’re now suddenly earning far lower fees from borrowers as a result of not writing so many new loans. Given everything I’ve said about platform stability, it’s far preferable to pay an extra fee rather than have the platform fall into trouble, so I can’t be too upset about it.
Loanpad is the smallest lender I have funds with, and their CEO Louis Schwartz was kind enough to reply to my email asking a few questions about how they’ve been coping.
He said that they saw a similar rush of investors wanting to withdraw in the first couple of weeks of March, but they were able to meet this demand – and within a few weeks, they had more deposits than withdrawals again.
Regarding the loans themselves, Louis says:
We see no likelihood of any losses for our investors or even our lending partners. Some of the development loans will take slightly longer to exit due to corona-induced build delays, however as we are such low LTVs there is no concern at all on any loan we hold of any foreseeable losses.
So all is looking good so far. The underwriting of Loanpad’s partner might be better than some other platforms (I suspect it is somewhat) and their LTVs are lower, but their main win is that by meeting redemptions they’ve maintained the trust of their investors. Of all the platforms, I suspect Loanpad will come through among the best.
I don’t have any detailed information about Kuflink, but they don’t offer any “instant access” type accounts so it seems that they haven’t been affected by the sudden rush to withdraw that other platforms have had to deal with.
I’m aware that they’ve been extending loan terms to allow borrowers time to complete their project and sell or refinance, which is entirely understandable. It’s too early to say if there’ll be any issues with repayments when that extension period ends.
Kuflink offers a Marketplace so investors who’ve chosen to invest in individual loans (rather than one of the auto-invest accounts) can offer to sell to other investors before the end of the loan term and get out early. Currently, there are roughly 30 loan parts listed on the Marketplace. I don’t know how this compares to the level of supply before COVID-19, but it doesn’t seem like a shockingly large number so it implies that investors are relatively calm.
We'll see the quality of Kuflink's underwriting and collections as more loans reach full term, but given the history of the company I suspect they're pretty good and they'll come through well.
Platforms struggling. Loans defaulting. Money trapped. Investors unhappy. Is this the end of P2P?
Predictions are dangerous, but I think this might be the beginning of the end of P2P as we know it. I believe it will live on, but will look very different in a couple of years from how it does today.
Let me explain…
When P2P first started over a decade ago, investors needed to look at each individual borrower seeking funding and decide who to lend to. After making the loan, they wouldn’t see their money again until the borrower repaid. (Later, “secondary markets” came about so investors could sell out early to another investor who wanted to take their place.)
As P2P became more popular, we saw the rise of the “access account”. It’s only actually Assetz Capital who use the term “access account”, but I use it to refer to a product where:
The innovation of this type of product helped P2P to go mainstream. Suddenly, you could earn a decent return on your money without having to be a part-time underwriter – and without locking your money up for a year or more.
This innovation was important, but it’s the cause of many of the problems investors are experiencing now. Why? Because it works perfectly until everyone suddenly wants their money out at the same time.
The technical term is “liquidity mismatch”: a platform might be making a loan for 12 months yet telling the lender they can have their money back tomorrow if they want it. The only way to do that is to replace them with another lender. When everyone wants their money back and there’s no-one coming in to take their place, there's no liquidity and the only option is to wait for the underlying loans to repay – which is exactly what’s happening now.
Platforms are careful (because the regulator requires them to be) in their terms to stress that access to your money is only possible “under normal market conditions” and is not in any way guaranteed. But it’s one thing to tick a box acknowledging that you understand and agree with that, and quite another to actually wake up one day and discover that you can’t access your savings for some unknown length of time.
In short, “access accounts” allow you to treat P2P lending like a high-interest savings account – which it’s not, never was, and never will be. Even though I knew this intellectually, I was still guilty of thinking of the funds I had in access accounts as being “cash-like” and assuming I could get at it when I wanted to.
As we’ve already seen in this article, it’s this sudden investor anger and rush for the exit that’s causing platforms trouble at the moment – far more than struggling loans. As a result, I think many platforms will come to the conclusion that the extra funds these accounts bring in isn’t worth the hassle, and will stop offering them – or at least will have minimum terms of a year or more.
I also wouldn’t be surprised if the FCA takes a look at this and decides to put a stop to access accounts completely. It’s clear that many investors never truly understood the implications of what they were signing up for, so the FCA could be seen to be protecting future investors if they stopped platforms from promising access or required far more stringent restrictions and warnings around them.
All of which is a long way of saying: I think P2P in the sense of “chuck your money in like a savings account without thinking about where the money’s going” will have gone away or been greatly curtailed in a couple of years’ time – whether the platforms do it themselves, or they’re forced to by the regulator.
The alternative to “access accounts” is investing in loans that have a specified term, with no right to get that money back until the term ends and the borrower repays. As I’ve said, some platforms pair this with a “secondary market” that opens up the possibility of exiting by selling your stake in a loan to someone else who wants to buy it.
Strangely enough, I’ve had better liquidity from platforms that don’t promise liquidity over the last few months. I’ve had several loans that just so happened to be due to be paid back in June and July, and they were – so the cash came straight to me.
However, this type of lending still has uncertain liquidity: if you lend for a term of 12 months, you might not necessarily get your money back after a year because the borrower might need an extension or not repay at all.
Platforms offering this type of lending won’t have to deal with the “sudden rush for the exit” phenomenon, but a downturn will reveal what the quality of their underwriting is like and how robust their processes for dealing with defaults are. Property development loans in particular are difficult to value properly (so it’s easy to lend too much) and there’s a lot that can go wrong throughout the course of a 12+ month project.
On the platform that I used to be involved in running (but haven’t been since September 2018), I was exposed to several loans on projects that didn’t pan out as they were expected to. Nevertheless, I didn’t lose capital or interest because the platform managed the relationship with the borrower well and found a resolution. It’s only when the chips are down that you discover which platforms are set up to do this well, and which aren’t.
Some platforms will turn out to have made loans they shouldn’t have done, will suffer defaults and may collapse completely. In general though, I think this model of lending will survive: it’ll just be more niche, because it doesn’t have the “instant access” appeal and the risks are more apparent.
Way before anyone knew what an R-number was, a couple of major platforms turned away from “retail investors” (AKA everyday people like you and me) completely and decided to take all their funding from institutional sources instead.
Why? Because of precisely what we’ve seen over the last few months: retail investors suddenly want all their money back at once as sentiment shifts. Institutions are more willing to be tied in for years at a time, and won’t start leaving arsey Trustpilot reviews as soon as something doesn’t meet their expectations.
I expect more platforms to close to retail investors because their recent experience will teach them it’s too much trouble, and those that remain open to retail will struggle to attract investors because they’ll be forced by the FCA to tone down the claims they make in their marketing.
This belief is backed up by Stephen Findlay, from direct lending platform BondMason. He said:
There will be fewer platforms, many will move away from retail (to reduce /remove regulatory pressure and/or because they have got institutional funding – and the institutions don't want to invest alongside the crowd…The ones that remain should be the strongest in terms of doing the right thing by their clients and delivering solid (sustainable) returns.
I wrote at the beginning of this year that I’d be maintaining my level of investment rather than adding to it, and that’s still what I’m planning to do. However, I’m going to be re-balancing where those funds are invested.
At the moment, the risk/reward is way out of whack on some platforms. Ratesetter, for example, has temporarily cut its interest rate to 1.5%. I understand why they’ve done it, but when you can get around 1% in a fully insured bank account it makes no sense for an investor.
As a result, I’ve requested a withdrawal from Ratesetter so I can deploy those funds into other platforms. I missed the rush on this and there are still many thousands of people ahead of me in the queue, so I’m not holding my breath.
Roughly the same is true for Assetz Capital’s Quick Access Account. I was willing to accept a low-ish interest rate in exchange for liquidity, but as that liquidity is unlikely to come back for a long time it doesn’t make sense anymore. I’ve requested a partial withdrawal, which I may invest in individually selected loans on the same platform or shift to a different platform.
I’m happy with my investments in Kuflink and Loanpad, so I’ll be holding steady there and probably topping up as I get funds out of other platforms. I may also dip into a couple of new (to me) platforms that seem to be holding up well, for extra diversification.
In general, my strategy is moving away from “lower returns for easy access”, and into “try to achieve somewhere from 4-8% on secured loans by locking up funds for up to a year”.
A good way to achieve this would be by shifting more towards investing in individual loans rather than term-length accounts: by doing that consistently, there will always be something repaying at any given time so I’ll effectively have rolling liquidity. That will involve a bit more effort, but might be the way forward.
Yes and no.
I’ve certainly made mistakes with my own strategy. Even though I’ve always known (and have consistently written) that liquidity will dry up when the economy starts to struggle and investors get spooked, I think I undervalued that risk because I arrogantly assumed I’d see the signs of trouble and make moves early. Needless to say, I didn’t anticipate a pandemic – and that’s not an excuse, just a reminder that you’re never as smart as you think you are.
However, I’ve also done some things right. I’ve stayed true to what I’ve preached about not investing more than I can afford to lose, and I’ve not chased high rates by investing in more speculative platforms.
What about my enthusiasm for the sector as a whole? That’s not been overly dented by the events of 2020, but I do think it will be the trigger for a shake-out that will see the P2P sector find its true size and shape.
The outcome, I think, will be a sector that’s smaller, more niche, less accessible…and probably better for it.
I think it’ll find its sweet spot in making loans against complex property and business assets, which banks don’t have the processes or desire to underwrite and where the borrower is willing to pay a higher rate of interest in return. The investors on these platforms may still be retail, but will be more sophisticated: they’ll know they’re tied into the loan for the duration, so will need to have a better understanding of what they’re lending on to get comfortable.
The journey to that new future is going to be a bumpy one. The drum I’ve been banging consistently is the importance of platform selection: speaking very broadly, as long as a platform survives the outcome will be at worst “not great” even if there are defaults, but if it fails it’ll be a disaster.
As investors we just need to hope we’ve chosen wisely, and that the sector as a whole will find its way through.