REURN TO LENDER
In 1999, a teenager named Shawn Fanning changed the music world for ever. With a piece of software called Napster, he made it possible for people to share their music collections with anyone across the world, almost instantly.
Napster was quickly taken down by lawsuits, but the idea it spawned is spreading out of the digital world, changing not just music but also movies, hotel booking (through firms such as Airbnb) and gambling, before now reaching finance.
In an era of buoyant stock markets, overpriced bonds and negligible deposit account rates, peer-to-peer finance offers the possibility of finding the holy grail of investing: lots of yield without a corresponding amount of risk.
The logic of peer-to-peer investing is simple. There are lots of people and firms who need to borrow money and, at the right rate of interest, plenty of people willing to lend it.
Banks, which are supposed to match both sides, are inefficient and uncompetitive, while the spread between the rates that banks charge and the rates that savers get are high, partly because banks have higher running costs — all those branches — and partly because of that lack of competition.
Peer-to-peer businesses connect lenders directly to borrowers — in essence, allowing savers to become their own banks. Though almost all firms still take a cut out of the middle, both borrowers and lenders can get better rates — at least in theory.
The longest, most established peer-to-peer lenders in Britain are RateSetter and Zopa (pictured above). These firms do what Napster did but for borrowers and lenders — connecting fairly modest savers with borrowers who need short-term unsecured personal loans or businesses plugging finance gaps.
Such firms do their own due diligence, applying strict high street-style credit checks to borrowers, but since loans are unsecured they rely on people spreading their lending across lots of firms to reduce the risk and ensure a decent return — typically between 3 per cent and 5 per cent.
Having already lent £165 million and £450 million respectively, RateSetter and Zopa are increasingly keen to attract HNW investment. Zopa’s largest individual lender has handed over ‘well in excess of £1 million’.
More exotic opportunities offer higher yields. One business directly targeting HNWs is HNW Lending, which was founded in 2011 and became operational last year. Unlike most peer-to-peer business, this firm is not actually dependent on its technology. Rather it directly arranges loans from HNW investors directly to HNW borrowers, secured against collateral.
Picture above: ‘So all you have to do is put in your bank account details and you’ll get 20 per cent interest per year? Don’t see why not’
Loans can cover everything from business investment to divorce cases, says Ben Shaw, the company’s director — he recalls one client ‘who had agreed to buy a yacht, but he hadn’t got around to selling his first yacht’. He secured the loan with fine wine. This sort of secured borrowing used to be covered by private banks, says Shaw, but they are increasingly tight-fisted thanks to regulation.
These tight-fisted banks offer another opportunity: lending to property developers. According to Stuart Law, the CEO of Assetz Capital, a peer-to-peer lender for businesses with tangible assets, ‘Banks are currently unwilling to lend to many businesses that are in fact very creditworthy.’
House prices are soaring, but many small- and medium-sized developers still struggle to get funding; interest rates can be as high as 20 per cent. Last year, Assetz Capital lent £1.75 million for a student halls of residence in Nottingham — a record recently broken by LendInvest, a similar platform, which in January agreed a £4.1 million loan for a housing project in Croydon.
More so than firms making smaller loans, Assetz Capital is extremely keen on HNW lenders. HNW investors are invited to join Assetz Capital’s ‘underwriting panel’, which allows them to do their own due diligence on loans, speaking to borrowers and looking at accounts before the loans are put out to bidders on Assetz Capital’s website. They can also ‘pre-bid’ on loans larger than £250,000 — in effect guaranteeing the entire loan.
This, says Law, is popular with HNWs, who like to know what they are investing in, but also means that his own employees have a backup when assessing the creditworthiness of any business proposition. And the online platform means that loans can be sold on into a ready-made secondary market, so they are relatively liquid investments.
A running start
For the most ambitious investors, peer-to-peer finance increasingly offers the ability to buy equity as well as debt. Crowdcube, a British firm, has now raised £18 million for 92 businesses — mostly, but not entirely, start-up firms. Luke Lang, Crowdcube’s co-founder, says that the idea was to open up the world of angel investing, which previously ‘meant going to lots of meetings in dreary hotels’, as well as investing very large amounts of money.
Investors can get generous tax relief under the EIS and SEIS schemes, which helps reduce the potential losses of lending to start-up firms (necessary, given that 60 per cent of start-ups fail). But whereas traditional angel investors have to rely on their own wits, Crowdcube investors can spread their money between lots of firms, collaborating with other investors to judge how likely their investments are to thrive.
Such investments are not for everybody. Crowdcube investments are still extremely illiquid — though Lang is keen to build a system whereby parts of firms can be sold on. Lending through the likes of Assetz Capital or Zopa offers a more secure, liquid return, but these have their pitfalls too.
Peer-to-peer lending is not yet easy to make tax-efficient: money cannot be invested in an ISA wrap (though this may soon change), nor can losses be written off against tax, which for higher-rate taxpayers can drastically reduce returns. Most firms make up for this by charging a fee which funds a capital pot to cover losses — and few firms have lost money for their investors yet.
In the event of a major recession wiping out lots of debtors, peer-to-peer lenders could easily go bust, leaving lenders with a large number of tricky-to-reclaim individual debts and without the public backing that bank savers get.
Rates of change
But perhaps the greatest worry is that the frontier is moving. Most peer-to-peer funds are cagey about it, but institutional money is increasingly entering the market as fund managers seek out higher returns than can be made in equities or bonds. That and the rapid growth of the market mean interest rates charged are tumbling — rates at Zopa and RateSetter are already sharply lower than a year or two ago.
Given that deposits are only barely protected by law and are not always particularly liquid, it may no longer be worth it. As personal lending gives way to lending to property developers, the risk rises commensurately — there are good reasons why banks are often unwilling to lend to property developers after all.
Still, chasing whatever is new is what HNW investors need to do to make their money work in today’s world. Equities have had a good run of late, but with interest rates likely to rise, that may not continue for ever. Bonds still seem overpriced. And the banking system looks set to remain broken for a while.
Of course, there is one alternative: buy a yacht. With the rise of peer-to-peer lending, these days it is easier than ever to get a loan to cover the cost.
Daniel Knowles is the Britain correspondent of The Economist
500% – Projected growth for the peer-to-peer industry over the next three years
$3bn – Value of all loans serviced by Lending Club, the largest US P2P lender
58 – Number of the nearly 1,000 P2P companies operating in China which went bankrupt in the final quarter of 2013
£400,000 – What HNWs would lend on average, according to Assetz Capital