29 November, 2018

P2P Rates Rising in Consumer Lending

P2P Rates Rising in Consumer Lending

The UK’s three largest consumer lending P2P platforms Zopa, RateSetter and Lending Works have all raised investor rates in the past year. For the 3 years prior all three have had their rates squeezed as competition from traditional lenders and new bank lenders, such as Sainsbury’s Bank, increased.

With heightened competition for borrowers, investors on these consumer lending P2P platforms have had to accept a lower return for the same risk. It’s therefore a welcomed relief to see a trend of increasing returns emerge in the past year.

The chart below shows this general trend for RateSetter’s 5-year product.

Figure 1: RateSetter's 5 year market rate

Lending Works increased their rates initially in January 2018 and subsequently again in November 2018. Rates are now the highest they have been in 3 years.

Figure 2: Lending Works 5 year and 3 year rates

Similarly, in September 2018, Zopa increased their rates across both their core and plus products from 4% to 4.5% and 4.6% to 5.2% respectively.

Although not meteoric, these uplifts are positive for investors and brings returns of P2P consumer lending closer to returns in the P2P business lending sub-sector. Both RateSetter and Lending Works products come with an added benefit of a fully functioning provision fund, increasing the predictability of investor returns. The key question I have is whether this is a better deal for investors or are investors exposed to more risk?

With higher investor rates we would expect higher borrower rates, or an expected fall in defaults. Lending Works and Zopa publish their borrower rates as shown in the table below. It can be seen that Lending Works borrowers are paying almost 2% more in 2018 compared to 2017, while Zopa borrower rates have dropped from 2017 to 2018.

2014 2015 2016 2017 2018
Zopa 7.4% 7.8% 9.9% 10.3% 9.4%
Lending Works 7.7% 9.2% 9.3% 9.7% 11.8%

Figure 3: Weighted Average Borrower APR of Loans Originated that year

If the expected default or bad debt (default minus recoveries) rates at the platforms were to rise during this period this would indicate that an increase in returns is a result of an increase in risk.

Figure 4: Projected default and bad debt rates

Lending Works are forecasting that their bad debt rate will drop from 5.6% in 2017 to 4.3% in 2018. Although borrowers are paying more for their loans, they expect a lower bad debt rate, implying that investors are taking less risk for the higher returns received.

Similarly, Zopa have reduced their default expectations in 2017, 4.52% to 2018, 3.32%. This is in line with Zopa reducing the amount of lending in their higher risk, higher return D-E category loans announced in August 2017. Similarly, this would imply that investors are receiving higher returns for less risk.

RateSetter’s expected bad debt rate is anticipated to increase this year, indicating that investors might be taking on more risk when investing on this platform. It’s worth noting that RateSetter lends to both businesses and consumers with 30% of their 2018 origination to date relating to business lending.

On the Lending Works and Zopa platforms, an increase in returns but a decrease in expected defaults suggests that investors are getting a better return for less risk. There are two other potential reasons for this. Firstly, there might be an imbalance at these P2P platforms with an oversupply of borrowers needing capital vs. the amount of people wanting to invest. This would drive up investor rates. Secondly, the cost of borrowing is rising in general as a result of two interest rate rises in the past year. The competitive landscape has changed with all consumer borrowers now paying more as a result of these interest rate rises. How P2P will fare as interest rates rise is a point continuously challenged by sector onlookers and this could be an early sign that P2P rates will rise in line with interest rates.