editorial report â€˘ summer 2013
peer-to-peer lending supported by
2 Interactive Investor | Peer-to-Peer Lending | August 2013
Join the social lending crowd
Social lending offers savers the chance to become lenders, earning higher interest rates than the banks currently offer
BY SALLY HAMILTON ick of the banks, their paltry savings rates and tightfisted attitudes to lending? Well, join the growing club – or rather, crowd of consumers turning to the expanding breed of internet-based services that aim to give lenders and borrowers a better deal through so-called crowdfunding. By cutting out the middlemen with their expensive workforces, bonuses and branch networks, these operations pair up savers with borrowers online in peer-to-peer (P2P) or social lending arrangements that aim to give ‘savers’ – who are actually lenders – a higher return on their money. In fact, interest rates currently on offer range between 5 and 8 per cent before tax, outclassing those on most conventional savings accounts, where the top rates for a cash ISA are hovering around 2.5 per cent. Depending on which P2P service they choose, savers receive returns either in the form of interest or potential equity returns when they’re lending to businesses. Interest in the sector is growing steadily, with the UK P2P market heading for £500 million
worth of lending this year. It was pioneered by Zopa eight years ago as the first online agency for individual borrowers and lenders who agree their own rates between them. ‘We are a marketplace, not a bank,’ it insists. Although the market is still of minnow proportions, it has now expanded to include players such as RateSetter, offering similar consumer credit arrangements to Zopa, and the likes of Funding Circle and Squirrl.com all specialising in lending to cash-starved businesses. In the next couple of months, Zopa will also start offering loans to the UK’s 3.5 million sole traders, thanks to a £10 million injection from the government Business Finance Partnership package. There are also newer types of peer-to-peer lenders such as Relendex which provides an online platform where groups of savers can club together to provide commercial property mortgages. Anyone willing to invest £5,000 can join the platform. In a typical deal borrowers will pay around 6 per cent interest and savers will receive around 5 per cent. Relendex takes a 1 per cent matchmaking fee providing borrowers with total sums of £500,000 to £10 million. Average loan size at the consumer-focused operations is £5,000, with the majority of lenders being male Middle Englanders, aged 45 to 50-plus. The typical borrower
Savers get over 5 per cent interest on Relendex secured loans
is also a Middle Englander, taking an average loan of £5,000 over three years, who wants the cash to make large domestic purchases such as a new kitchen or car, according to their loan-profile information. Funding Circle’s loans, which are for businesses, average around £65,000, but the profile of the average lender is also about 50-plus, who invests £5,000. James Meekings, co-founder of the company, says: ‘They tend to be people heading towards retirement who are feeling let down, not just by savings rates but by the volatility of other investments, and need an income from them.’
NO HIGH EXIT PENALTIESSdS Lenders aren’t just attracted by rates. Another advantage is loans can be sold on to other lenders before maturity without the high exit penalties associated with some fixed-term savings accounts. Meekings admits there’s no guarantee loans will be sold on and they could be sold at a loss. However, the process can be quick. ‘My fellow director got all his money out in two hours recently when he needed it to buy an engagement ring for his fiancée,’ he says. At Zopa, there’s a charge of 1 per cent of the original loan for those cashing in immediately (unless the borrower has defaulted). Although the terms P2P and crowdfunding are often used interchangeably, the latter
Interactive Investor | Peer-to-Peer Lending | August 2013
SoCiAl lenderS’ rAteS And CHArgeS Social lender
5% to 7.5% per annum secured
6% to 8%
1 per cent per annum paid by borrower only
Secured on income-producing property
Average 5.2% (before tax after charges and defaults)
6.7% APR, 3-year £5k loan
Borrowers: fixed fee; lenders 1 per cent a year
Loans spread, risk banding, credit checks, segregated account, independent collection agency
3.7% to 6.4% (before tax, after charges)
7.2% APR, 3-year £5k loan
Lenders: 10% monthly interest; borrowers admin and credit fees vary
8.8% (before tax, charges and defaults)
7.1 per cent to 9.4% APR
Lenders 1 per cent annual fee; borrowers fixed fee (eg 2% on 1-year loan, 3% on 3-year loan)
Loans spread widely, segregated account
N/A as equity. Possible rewards such as business’s product or service
N/A, although issue shares to investors
Investors, none; businesses pay 5 per cent of target amount if met
Regulated by FCA, underlying investment may be protected under FSCS
tends to describe online equity investment platforms, an area that attracts wealthier investors. Luke Lang, co-founder of Crowdcube, which acts as an online introduction agency for businesses that pitch online to its register of 31,000 investors, says: ‘We differ in that debt finance services tend to lend money that is repaid within three years. With us, it’s equity
Plans are afoot for the FCA to regulate loan-based firms from 2014 and the investor has a legal standing and gets a share certificate. Any payback is further down the line. It could be in three, five or eight years’ time before the business is ready to exit or sell. The absolute risk is they might not get anything back but there is the potential of high returns.’ Although the risk of P2P lending is relatively low, a significant drawback for savers/ would-be lenders currently is most of the P2P organisations cannot be part of the Financial Services Compensation Scheme (FSCS), which steps in to rescue savers with conventional bank accounts by up to £85,000 if their provider goes bust.
REGuLATING LOAN-bASEd SERvICES However, plans are afoot for the Financial Conduct Authority (FCA, formerly the Financial Services Authority) to at least regulate the loan-based operations from April 2014, while equity-based services are already regulated, and in some circumstances may offer compensation through the FSCS if an investee company goes bust. Recognising such security concerns, the three biggest players – Zopa, Funding Circle and RateSetter – set up the P2P Finance Association to lay down high minimum standards of unofficial protection, which range from spreading your savings around numerous borrowers to setting up a fund designed to cover any losses (see table above). In the case of Relendex, property loans are monitored by a team including former lending officers at Rothschild Banking Group and headed by Peter Johns, a former head of banking at NM Rothschild. However, one danger is that rate hunters could desert social lenders in droves when bank interest rates rise. But Meekings believes the P2P model will still be attractive. Alex Gowar, marketing director of RateSetter, adds that the sector has time to build up credibility. He says: ‘We operate as if we are regulated already. Our provision fund is paid for by a small payment from every borrower.’ So far, no one has lost any money, but Gowar concedes a worse-case scenario of when the ‘pot could run dry’.
4 Interactive Investor | Peer-to-Peer Lending | August 2013
STRICT CHECKSXXXX Strict credit checking is key, he says, and as a result bad debt rates at RateSetter run at an average of 0.34 per cent , compared with the banking average of 3 to 5 per cent. Gowar says: ‘Banks charge higher APRs on the loans as a result. We see ourselves as a risk management company. It is in our interests to be strict as to who we allow to borrow. Only about 12 per cent of those who apply are approved.’ P2P is a long way yet from being a mainstream threat to the banks. To put it into context, the lending of Funding Circle, RateSetter and Zopa amounted to £250 millon last year, while the main banks lent £75 billion to businesses. However, Liam Collins, policy adviser at Nesta, a charitable organisation that monitors the P2P market, believes the sector will thrive and its research suggests it could account for as much as £7.5 billion, or 10 per cent, of business lending within five years. Elements of P2P, such as giving investors a clearer view of where their savings are invested, might appeal to their rivals, the banks. However, it’s more likely the banks will be content to just let P2Ps go on eating the crumbs from their collective table, just so long as they don’t get too hungry. As Anderson, says: ‘We do a lot of what the banks do, apart from manufacturing money. The banks are good at that and will continue to be good at it. But we’re good at fixed-term instalment loans and we will continue to take this narrow niche.’
Relendex Peer-to-Peer Lending
Secured on property Introducing secured peer-to-peer lending
Thorough due diligence protects lenders
Relendex is a revolutionary new online exchange where investors
The Relendex due diligence process is extensive and carried out by
seeking fixed returns of 5%-7.5% per annum coupled with high levels of
a Lending Team consisting of former senior lending officers from
security can lend money to the owners of income-producing commer-
Rothschild Banking Group. Loan to Value (LTV) and Interest Cover
cial properties. Each loan is made up by a group of lenders, who each
Ratio (ICR) are key indicators. Additionally they assess the property,
provide a portion of the total, and the resulting loan is secured by a first
locality, market conditions, tenancy schedule, tenant quality, lease
legal charge against the property asset in question providing a high
profiles and competence of the borrower to manage the property.
level of protection for capital. Loans are from 3 to 5 years.
They then “stress test” the projected cash flows from the property using different assumptions about void periods and re-letting terms.
A bright spot in a world of low returns
This risk assessment is then used to place each loan into one of four
Providing acceptable returns on cash at low levels of risk has become
and return profiles. Their report together with a formal valuation and
extremely difficult as interest rates have sunk to long-term lows.
Certificate of Title are available for viewing by registered lenders in
Relendex offers investors and savers a viable alternative by opening
the Virtual Data Room.
indicative risk bands – A* to C – as a guide to lenders to assess risk
up a new asset class previously unavailable – direct lending secured against quality industrial, office, retail, leisure and some residential properties. These are subjected to a thorough process of due diligence
Relendex to be regulated by the FCA
to ensure that they produce robust cash flows and are therefore well
Peer-to-Peer lending platforms will be regulated by the Financial
able to service the loans arranged.
Conduct Authority from April 2014 and Relendex is now preparing to become a fully regulated entity. It already manages processes in ways
Secured P2P lending – Your Choice
consistent with what regulators will demand and the Board includes
Lenders use the Relendex online platform to view a range of secured
cial services businesses. Relendex itself does not handle clients’
loans and select those that match their target return and risk profile.
money, which is held at all times in segregated accounts by a custo-
You decide how much to allocate to each lending opportunity and what
dial bank, Royal Bank of Scotland International, Guernsey.
people will long experience of working in regulated banking and finan-
interest rate you are willing to accept – so you only take the opportunities that work for you.
Can I get my money back early if I need to?
Who are Relendex lenders?
Relendex is developing a secondary marketplace by Q4 2013 so that
Relendex is suitable for anyone managing a
members will be able to sell some or all of their existing loan parts to other lenders.
small or large investment portfolio from professional fixed-income investors like family offices, pension funds, insurance companies and private banks, to individuals saving for homes, education or retirement. Lender Accounts range from a few thousand to millions of pounds. You can open an account with £5,000. The minimum investment per deal is £1,000. There is no maximum investment
Any further questions? If there are other matters not covered above or answered on the Relendex website then you can call Relendex on 0800 096 7373 anytime or email firstname.lastname@example.org Interactive Investor | Peer-toPeer Lending | August 2013
pooling ooling risks to reap rewards
Exciting future Crowdfunding is a new industry that is making a growing contribution to SME debt and equity funding by acting as a bridge between businesses that need money and retail investors prepared to offer it to them in the hope of long-term returns. Leading crowdfunding companies have been pushing for regulation because they think it will give their businesses more legitimacy. Also, the growth in crowdfunding will generate further innovation as investors’ interest in private companies increases.
Accessing credit has become harder for small businesses, but websites pooling savers’ funds are stepping in as lenders, says David Prosser
eet Steve Lister Tyres, an independent business that has been operating profitably in the north west of England for six years. It has spotted a market opportunity: it already supplies new tyres and repairs old ones, but if it installs new equipment, it could also move into the recycling business. Re-treading worn tyres for re-sale has environmental benefits and should be a hit with customers since they’ll be
cheaper. The only catch is that a new production line will cost £50,000 – and that is cash that Steve Lister Tyres doesn’t have on the balance sheet. Traditionally, such a business would have had little option but to approach a bank for finance. But the firm has raised the £50,000 in a different way – through Funding Circle, the online crowdfunding business. More than 600 users of the site have offered to chip in to get Steve Lister Tyres to its target. Individually, they are lending sums ranging from £20 to £1,000 at an average interest rate of 9 per cent. The deal is typical of many now being done
The tax angle
On loan sites such as Funding Circle and ThinCats interest payments are liable to income tax as with savings income. No capital gains tax arises. On equity sites such as Seedrs and Crowdcube there is income tax to pay on dividends and CGT to pay on capital gains, unless investments are SEIS or EIS-eligible.
6 Interactive Investor | Peer-to-Peer Lending | August 2013
on a small but growing number of crowdfunding websites – others include ThinCats and RebuildingSociety. And the principle is identical to the traditional banking model in which savers’ money is pooled and then lent to borrowers in return for interest charges. In practice, there are crucial differences. Savers – Funding Circle’s users – get to specify at what rate they’re prepared to lend and to choose the businesses they are prepared to back. And there’s no bank or financial middleman involved – the website operates as a platform where would-be lenders can meet businesses in need of funding, but has no role in deciding who can borrow what. It is an idea that would not have been possible before the internet – the web is a medium through which one person can contact many others instantaneously. But the idea of harnessing the power of the crowd in order to fund businesses has particular appeal right now, in an economic environment where many firms are unable to secure finance from the banks. Moreover, if the demand for finance is pressing, so too are the needs of those who can supply it. ‘We have a steady stream of borrowers who have become frustrated with their banks,’ says James Meekings, one of Funding
‘The stream of savers is just as steady because we’re paying such generous yields’
James Meekings money back in full, which represents another risk to consider. Still, lending through crowdfunding sites is a more liquid option than the latest variation on the theme – providing equity rather than debt. Two crowdfunding sites, Seedrs and Crowdcube, are now leading the way on this front.
dEbT vERSuS EquITy
Circle’s founders. ‘The stream of savers is just as steady because we’re paying such generous yields compared to what conventional accounts are offering at the moment.’ The average yield on the site in December was 9.1 per cent, which compares very favourably to bank and building society accounts – even after charges of around 1 per cent a year are deducted.
COmmERCIAL PROPERTy SECuRITy Relendex, the secured P2P lending exchange, provides real estate loans for three to five years against commercial property and arguably offers a more secure way to diversify lending. Also, if you’re worried about liquidity, Relendex allows loan parts to be resold on its exchange on a ‘matched bargain’ basis. Savers do, however, take a risk for their reward. While a bank shelters its savers by taking the hit when borrowers fail to repay loans, there is no hiding from bad debt in crowdfunding. All the sites conduct some basic due diligence on businesses, which enables them to categorise loans by risk profile (more risky lending commands higher interest rates),
but the checks are not exhaustive. In any case, all lending generates at least some defaults. So far, however, crowdfunding has generated only low levels of bad debt – around 2 per cent – although while the £80 million or so the industry has lent in the UK to date is an achievement given its relative youth, this isn’t much of a sample. Moreover, the idea is that lenders spread their risks, making a large number of small loans so that individual failures can be borne relatively painlessly. The diversification process can even be achieved automatically. While lenders can choose which specific businesses to back by examining each request for funding, many choose to have their money allocated by the sites on the basis of set criteria – maximum investment in one company, say, or with restrictions on lending to more risky businesses. It is also possible to prioritise certain types of business – from certain regions, for example, or particular industry sectors. Loans are typically repaid over terms ranging from six months to five years, with borrowers making monthly interest payments. Lenders who need access to their starting capital early can sell their loans on through these sites, though there is no guarantee they will get their
The model is very similar to debt-oriented crowdfunding. Start-up businesses looking for capital make their pitch on the platforms, targeting a set amount of money from users, who each subscribe small amounts. The business only gets the cash if the target is reached in full. Clearly, investing in small start-up businesses is a risky venture for investors who stand a much bigger chance of losing their money than with other types of equity. Bear in mind too that sites such as Seedrs and Crowdcube do only limited checks on those raising money – to make sure they’re not crooks – but are making no recommendation to investors about future prospects. However, Luke Lang, the co-founder of Crowdcube, argues that crowdfunding is the first time retail investors have had the opportunity to make diversified investments into an area of the equity market where the failure rate may be high but where returns are potentially stellar for the handful that do make it. It may also help that many of the companies on these sites are eligible investments for the seed enterprise investment scheme (SEIS), so may come with tax breaks. By early December, Crowdcube had raised more than £4 million of equity for start-ups. ‘Many of our investors have built portfolios through the site, which was really important
Interactive Investor | Peer-toPeer Lending | August 2013
small businesses to us,’ Lang says. ‘Before crowdfunding, you would have needed hundreds of thousands of pounds to buy a number of stakes in such businesses and we’ve really changed that.’ There are other risks to consider, though – not least that question of liquidity. No secondary market exists to enable investors in Seedrs or Crowdcube companies to cash in their stakes (though both are exploring this option). That leaves investors playing a longterm game of uncertain duration – they will only get their money back, hopefully with a profitable return, when the business is sold or goes public. Even then, there are costs to consider. Seedrs, for example takes 7.5 per cent of any upside when investors get their money back (as well as of any dividends paid in the meantime, though these are rare). It is for these reasons regulators have their concerns. Last August, the Financial Services Authority warned: ‘Most crowdfunding should be targeted at sophisticated investors who know how to value a start-up business, understand the risks involved and realise that investors could lose all of their money.’ However, Jeff Lynn, Seedrs co-founder and chief executive, insists his site’s users already have their eyes open. ‘They know failure is part
of business,’ he says. ‘They’ve made it clear to us they understand many of these businesses will fail.’ In fact, Seedrs has been able to negotiate FSA authorisation having spent more than a year working to meet the regulator’s requirements. But investors doing business with other firms will not have recourse to services such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. That may soon change, however. At the end of last year, the Treasury announced that it is studying how regulation could be introduced across the crowdfunding sector, to bring companies under the control of the Financial Conduct Authority in 2014. Simon Deane-Johns, a solicitor at Keystone Law, thinks regulation could help the sector. Deane-Johns, one of the founders of Zopa, a site that enables savers to lend to individuals rather than businesses, says nervousness among savers and investors is one of the things holding crowdfunding back. ‘It will be important to ensure the regulatory detail supports the growth of peer-to-peer lending as an alternative to bank finance,’ he adds, ‘and that tax incentives which favour banks are realigned to level the playing field.’
‘Relendex is a mechanism to provide muchneeded capital for borrowers and good potential returns for investors.’ relendex co-founder and chief executive Michael lynn c lick here
Relendex, a P2P lender for secured loans on commercial property, lets you view key documents such as valuations and titles in its online virtual data room Interactive Investor has worked in association with Relendex in preparing this report and will receive remuneration
8 Interactive Investor | Peer-to-Peer Lending | August 2013