In the past six months we have seen major changes at the large peer-to-peer (P2P) platforms. For us, as industry commentators, this keeps things interesting. For investors, however, this may be unsettling. One investor who we recently spoke with stated, ‘this is not what I signed up for’. Structural changes to P2P platforms impact investors and need to be fully understood to maintain confidence in their investment decisions. This can be frustrating for investors on the large platforms who have a long-term strategy and don’t expect to be continually re-evaluating those decisions.
On the flip side, the industry is still in an exciting phase of growth with continued innovation. We suspect that as time progresses significant changes within the top P2P platforms will become increasingly muted. However, for now, we’re still seeing big swipes at the way the platforms operate.
We’re keen to examine the recent changes at the largest P2P platforms and how they affect lenders, both for the good and the bad. In this article we’re focusing on the product and market condition changes at Zopa.
Zopa Lending: Zopa ISA & Other Changes
14 months after Zopa axed it’s ‘3 Year’ and ‘5 Year’ fixed term products in favour of a new generation of lending products – ‘Zopa Classic’, ‘Zopa Access’ and ‘Zopa Plus’ – the platform announced further product changes in June of this year. These changes coincided with the launch of the Zopa ISA and included:
- The phasing out of the Zopa Safeguard (provision) fund
- New investors will not be offered the Safeguard fund
- Existing investors will continue to benefit from the Safeguard fund until December 2017 – with loan terms of upto 5 years, the fund won’t be fully phased out until 2022.
- Restructuring of the Zopa products
- Launch of the Zopa ISA
So, are these changes good for lenders?
Although the Safeguard fund may appear to reduce lender risk, ultimately, the loans which the investor is exposed to remain the same. The Safeguard fund does not create additional risk mitigation or reduce the risk of default. Safeguard, or “provision funds”, skim a proportion of borrower repayments which reduce investor returns to cover losses. This reduces the volatility of the returns but does not reduce the overall risk. The presence of the Safeguard fund can confuse the underlying risk investors are exposed to and therefore I’m personally in favour of its removal.
Investors in ‘Zopa Access’ who enjoyed easy access to their funds at no cost may be disappointed with the loss of this product. Products advertised as providing early access may be perceived as having increased liquidity – this may be misleading. Generally, these early access products are still made up of loans which have the same inherent liquidity as standard products, so in the interest of product clarity, I’m again in favour of this product change.
Zopa Lending: Consumer Market Update
Not a change in Zopa’s operation, necessarily, but the platform did announce in a recent blog post that default and insolvency levels are rising, not just across the Zopa platform but across the consumer credit market as a whole. It was stated that defaults were reaching levels near the historic norms of pre-2010. The Bank of England expressed concerns around the consumer credit market early in the year stepping up scrutiny of lenders.
Zopa reports that it noticed this trend as early as January 2016.
In response to this, Zopa announced on the 22nd of August that it was reducing its lending to higher risk D-E graded loans which are included in the Plus product. As such, the expected return investors might expect on Zopa Plus has reduced from 6.1% in June to 4.5% in August. For existing lenders, although losses are higher than expected, the Safeguard fund has covered losses to-date and appears to have a sufficient buffer to cover losses. This is an example of where the Safeguard fund can compensate for unexpected volatility.
This is an interesting post by Zopa, who historically have experienced extremely low default rates for the returns on offer. The chart below shows how the expected default rates have risen from 1.3% in 2013 to 4.89% in 2017. In 2015, we saw actual default rates above expected and there are still 31% of loans open from this year.
Figure 1: Actual and Estimated default rates across the entire Zopa loan book (not product specific)
A further reason for these rising default rates, beyond market conditions, is that the spread of lending across Zopa has also increased. This can be seen in the table below, where we display an increased differential between the maximum and minimum borrower rates. The weighted average borrower rate has also increased as shown in the table below. It’s worth noting that this increase in lending scope did coincide with the introduction of institutional investors on the Zopa platform and later the higher returning Zopa Plus product.
Figure 2: Zopa Lending Amounts and Borrower Rates
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So, what is going on?
As discussed in a previous article, the consumer lending market has become increasingly competitive, not just from established banks but also new challenger banks, such as Sainsbury’s Bank or M&S bank. What Zopa is experiencing is felt across the entire consumer lending market. The banks are lending heavily into this space, which has driven up competition for peer-to-peer consumer lenders. After a quick search on MoneySuperMarket I was offered an indicative 5-year loan from Sainsbury’s Bank for 3.8%. This is where Zopa is competing, and this low cost of borrowing is hurting investors in the consumer P2P market.
Zopa deserves praise for its ability to continually grow origination. There is still strong lender demand for Zopa products and the platform has lent £723 million in 2017 alone, already surpassing the total 2016 figure of £623 million. This is still not enough origination for the demand, with a wait list for new lenders still in place. This growing demand and challenging market conditions may have steered the platform into riskier territory. Unfortunately, the lender has not received higher rates when comparing the type of lending currently on the platform to pre-2012.
Should investors be worried?
Zopa is the longest running P2P platform and has built up a strong track record of quality lending. In light of potentially challenging market conditions it is taking early steps to reduce the percentage of higher risk loans allocated to the Zopa Plus product. On the Zopa Core product, returns have been compressed further as the platform continues to lend to high quality borrowers.
Zopa Lending: Conclusion
As always, we’d encourage investors to diversify across multiple platforms. This is patricianly true if your portfolio is weighted to the consumer lending market, where yields are being compressed. The peer-to-peer business lending market has not experienced the same level of competition. This is a perfect example of why diversification within the P2P market is so important.