Risk vs return in the peer to peer lending (P2P) market is defined by the borrowers. The success of a P2P platform is measured by their ability to originate good quality borrowers; investors will gravitate to wherever attractive risk-adjusted returns are on offer. The size of the P2P market and the size of the P2P platforms is therefore constrained by the level of borrower demand in the market and, more critically, how effective the platforms are at originating borrowers.
“P2P platforms don’t need additional retail investors because they have institutional investors” is a common misconception I’ve heard on numerous occasions. This misconception extends further, insofar as institutional investors have tipped the balance with supply of capital outstripping demand from borrowers. With the exception of Zopa, who paused new lenders from investing on their platform in early 2017, this is not a systemic issue across the market. Institutional investors are good because they bring larger volumes of capital, but the downside is that the capital can be unpredictable. A new management team for example might have a different view on the previous team’s strategy. Retail investors are said to be more sticky, reliable and diversified, so it’s not true that institutions are favoured over the man or woman on the street wanting to invest £10,000. The door of peer to peer lending is still open to new retail investors.
Lending Works and RateSetter also compete in the consumer lending market where Zopa has struggled to meet investor supply and this is where the quest for borrowers is greatest.
Consumer P2P platforms Quest for borrowers
Ryan Weeks from Altfi reported in September 2017 that Zopa originates half of its loans from price comparison websites such as MoneySuperMarket and Confused.com. As the name suggests, price comparison websites focus on comparing prices and, in lending markets, this means rates. The P2P platforms are competing directly with traditional lenders on these sites.
Mario Lupori, Managing Director for Consumer Finance at RateSetter, told Altfi in the same post:
‘Put simply, the best quality borrowers are price sensitive and shop around for credit. So, by working with price comparison websites, we’re able to attract excellent borrowers, and of course the borrowers themselves benefit from the competition that these sites foster.’
Lending Works also indicated that 40% of their 2017 loans came from price comparison sites. Although this channel can be optimised to increase conversions, it will ultimately reach a cap and P2P platforms will need to find other methods to originate borrowers.
One area of large growth in consumer lending is point of sale finance, where consumers are offered loans at the point of transacting. I recently bought a sofa from DFS, and although I didn’t need to take out credit I was offered 0% finance over 4 years and the first year I didn’t have to pay anything. An incredible offer. When I asked the salesman, he explained that Hitachi Finance were behind the loans and DFS paid the interest as a package. 75% of their furniture is sold through credit facilities. With revenues of £762.7 million in 2016, this equates to approximately £572 million of loans or 83% of Zopa’s 2016 loan volumes by comparison… and this is just one furniture retailer.
0% finance arrangements are being offered during the sale of many major purchases: bicycles, kitchens, bathrooms, home renovations and the biggest segment, car finance. However, with the exception of a couple of partnerships between mobile phone providers, such as Giffgaff and RateSetter, and Unshackled and Zopa, the P2P platforms have not cracked this acquisition channel. Why? One reason may be the structure of P2P may not be appropriate for this type of lending. In the P2P lending market, platforms must meet a continued equilibrium between borrowers and lenders. If loans are offered instantly the capital needs to follow instantly to continue the user experience. In current market conditions, this would not be an issue. But, if there was a downturn and P2P fell out of favour amongst investors, the supply of capital may dry up. The bosses of DFS and other larger retailers will be aware of this, favouring balance sheet lenders that can give absolute assurance around supply of capital. Zopa’s move to gain a banking licence may be in part due to this structural stumbling block.
Overall consumer lending is on the increase as reported by The FT:
‘Overall lending to consumers, which includes overdrafts, has rocketed over the past couple of years, growing at an annual rate of nearly 10 per cent, as banks have returned to the market after retrenching in the aftermath of the 2008 financial crisis.’
FT, Source: Bank of England
With the P2P consumer platforms occupying less than 1% of the overall UK consumer-debt market there is plenty of room for growth. The P2P platforms need to find a way to compete with the large lenders in the consumer lending market to remove the cap of their current acquisition channels. This is a major challenge for the consumer-focused P2P lenders if they want to continue to grow as such a rate.