p2p lending: A review of the market

Despite being only a decade old, peer-to-peer lending (p2p) appears ubiquitous; particularly in the FIRE community. In six years, UK p2p lending has grown from a £200m market to an estimated £7.5bn one in 2018.

With interest rates and the returns on conventional cash investments still below inflation, p2p is an attractive alternative to traditional cash savings.

Since 2016 investors can hold p2p investments in the Innovative Finance ISA (IFISA), offering a further enticement to cash-weary investors.

Today, I’m going to have a look at the UK p2p market. Personally, I don’t have any p2p investments; it’s never something that has felt like it’d work for me. So I won’t be talking about it from a practical experience. If you have dipped your feet (or plunged right in) with p2p lending, do share your experiences in the comments!

History of p2p in the UK

The first p2p lender in the UK was Zopa. Starting up in 2005. Since those heady days, Zopa has been joined by over 80 firms (as well as some others that have been unsuccessful).

In 2014, recognising the rapid growth in the p2p market, George Osborne (then Chancellor) announced that p2p investments would qualify for being held in an Individual Savings Account (ISA). Offering p2p investors the chance to squirrel away their investments in a tax-efficient wrapper.

It took some time for the Innovative Finance ISA (IFISA) to get set up. It wasn’t until April 2016 that IFISAs finally launched. Even then, few platforms offered IFISAs due to regulatory hurdles.

The personal interest allowance also kicked in on 6 April 2016. Basic rate taxpayers could receive £1,000 interest tax-free and higher rate taxpayers up to £500. Somewhat reducing the desirability of putting p2p investments in an ISA wrapper.

But those setbacks haven’t stemmed the flow into p2p investments. Platforms are still struggling to match supply and demand; many platforms still do not offer IFISAs. Only 2,000 IFISA accounts were opened in the 2016/17 tax year, compared to 2.6m stocks and shares ISA subscriptions and 11.7m cash ISA subscriptions.

The market

As mentioned above, there has been rapid growth in both lending volume and the number of platforms. Lending volumes topped £5bn last year; and with a more than four-fold increase in the number of platforms.

Source: Chartered Institute of Securities and Investment (CISI)

Overall, the market is dominated by four big players – Zopa, Funding Circle, RateSetter, MarketInvoice. Together they control over 60% of the total market. Each are market leaders in their own segment.

Zopa is the leading consumer-to-consumer (c2c) platform and has an almost 50% market share in the segment. Funding Circle is the leading lender to SME businesses; last year lending out more than the traditional high street banks. RateSetter distinguishes itself by offers property and asset-backed loans. Finally, MarketInvoice is one of the market-leaders in the rapidly growing invoice-financing sector.

Regulatory authorisation by the FCA has held back the number of IFISA platforms. But over the tail-end of 2017 and the first half of 2018, authorisations have picked up. About 60 platforms are now fully authorised, and over 40 of those are registered with HMRC.

As an investment

The first big thing to remember about p2p investing is that, unlike traditional bank deposits, it’s outside the Financial Services Compensation Scheme (FSCS). That very much means capital is at risk.

p2p investors are open to both default risk (the borrowers default on money lent) and counterparty risk (the platform itself defaults). Also, whilst not specific to p2p lending, there is an element of fraud risk. With some high-profile troubles at US lenders and in other countries.

An issue that personally troubles me (harking back to my days as a forensic accountant) are legal and operational risks. Where the legal ownership of assets or funds is unclear due to poor record keeping; fraud; or operational oversights.

One of the selling-points for p2p lending is that returns are thought to be un-correlated with equity returns. This makes the investments particularly appealing for diversification purposes. One caveat to that is that: “When the $h!t hits the fan all correlations go to one!” (thank you to Karsten at Early Retirement Now for that saying).

However, p2p lending offers the possibility of significantly higher returns than both cash deposits and equity returns. Returns of up to 15% are not unheard of. The variability of returns makes appraising an expected return challenging. A number of FIRE bloggers have been carefully documenting their returns over the years (among others, Retirement Investing Today with RateSetter and FoxyMonkey with a number of platforms).

One particular criticism is that p2p investors are enticed to invest by the promise of an unrealistically high rate of return. At the moment, we have only a short period over which to assess return claims and have yet to (arguably) go through a full market cycle. This is an area that the FCA are keeping a particularly keen eye on.

Comparison of platforms

As mentioned above, I don’t have any p2p investments so I’m always on the lookout for platform comparisons. The CISI recently published an excellent (and comprehensive) platform comparison table which I share below:

p2p uk platform comparison

Source: CISI

Factors to consider

As there is such a wide diversity of p2p platforms it is difficult to compare p2p lending as an investment versus other asset classes. With that in mind, investors will need to compare different platforms and products to find ones that are suitable for them.

Some of the factors that investors should consider when investing in p2p lending are:

  • Cost: What charges does the platform explicitly AND implicitly levy on investors?
  • Robustness of provider: Whilst incredibly difficult to evaluate, it is worth thinking about who are the backers behind the platform?; Is the platform turning a profit (or making huge losses)?; How long a track record does the platform have?; What authorisations, controls and processes does the platform have?
  • No. of lenders / no. of borrowers: Are there large numbers of diversified lenders and borrowers? What is supply/demand like on the platform? Is there an abundance of lenders and little demand?
  • Diversification and risk-selection: Are loans diversified across a number of borrowers (type, size, sector)? Is it possible to specify what types of loans can be made and to whom?
  • Liquidity: How easy is it to get money out of the platform? Does the platform make it difficult to get money out? Can loans be encashed early and at what cost? Is there a secondary market for loans?
  • Default: What is the rate of default? (And perhaps more importantly) How is that rate calculated? How does the platform account for and deal with defaults?

Why I don’t invest in p2p

There are three main reasons I don’t invest in p2p (do let me know if there are holes in my thinking):

  1. Unlike my cash deposits, capital is at risk. In that sense, I’d lump it with my bond and equities investments and not my cash holdings. And given that, I’m quite reluctant to sell those investments to put it into p2p.
  2. The lack of correlation to other assets is enticing, but one of the first rules of finance I learned was that in market shocks the correlation of assets tends towards 1. We don’t know yet if this will also apply to p2p, so for now, the correlation stats have an asterisk next to them.
  3. The market is still quite young; there are lots of players out there – it feels like too many. I’d expect there to be some consolidation and some platforms going out of business. Trying to work out which platforms will be the winner seems like too much effort to me – in my ‘too hard pile’. I like my investing to be easy and lazy!

So for now, I’m sitting on the sidelines as a curious spectator.

Closing thoughts

It’s still early days in the p2p market, but it’s clear that p2p lending is here to stay. The big players and early movers are now establishing a track record. With overall rates of return and default becoming easier to gauge.

However, it’s not all been plain-sailing. With several high-profile problems at some platforms as well as some going out of business. Further, some platforms don’t seem to be sustainable in long-run, racking up huge losses.

p2p investing offers the potential to make higher rates of return than cash deposits and equity investments at apparently low levels of correlation to other assets. But in market crises asset returns tend to all move together, and p2p investing has yet to sail through truly choppy waters.

 

Please post a comment if you are (or were) a p2p investor. I’d be interested to know your experiences – both good and bad.

[Disclaimer: none of this post should be construed as a recommendation to invest in a particular investment or with a particular platform. This post is for information purposes only. Please do your own research, and speak to an FCA authorised investment adviser if necessary. I won’t take any liability for any decisions you make off the back of this post.]

All the best,

Young FI Guy

[p.s. I’ve just realised Monevator updated his RateSetter post whilst I was on holiday – http://monevator.com/ratesetter-high-interest-offer/]

Comments

  1. Hi. I currently have about 3% of my wealth in p2p and see it as fun learning money, it’s been really interesting checking out all the different models as an intellectual excercise and I love the idea of waking up the banks whose arrogance is unshakeable. So I’m keeping an eye on the sector for it to mature a little so as to be able to set expectations; at the moment I see it as at the riskier end of the investment option spectrum.

    I put significant amounts in Funding Circle and later Rebuilding Society, to experiment, and broadly found that if you left it to run on automatic, you hit a lot of the defaulters, so only got about half the advertised rate. If you did a lot of research and were hands-on, you could get into double figures (gross) but it was time consuming and still hard to ascertain how good their due diligence and recovery was. At the higher percentages advertised as possible returns, I got to feeling it was subprime and once the loanbook matured, even that would crash the early scores, whilst I worried a proper recession would cause a wipeout. It’s said we should expect a crash, or at least a noticeable correction every 10 years, so given the last was in 2008 and it’s now 2018, I pulled out and will watch others take the ice-bucket challenge when it comes.

    But if one comes up with a more transparent risk explanation and better default compensation strategies, I’d be very interested and generally would really like this asset class to succeed.

  2. I did until three days ago have about £1,300 in a Zopa ISA. I was a big fan of Zopa at first. It felt like a real marketplace where you could set your own rates in each risk market(A++ down to C). I was always happy to lend my money out slower at a few points above the “Zone of possible agreement”. I left around £500 in there and then logged in three/four years later and found the “marketplace” had gone.

    I stuck with it, and had it as a section of a somewhat small emergency fund. The section that should in theory never ever get touched but can be left to accumulate a bit of growth to compensate for the cash section inflating away.

    I was acutely aware from word on the street that a lot of people use zopa because it is so easy for everyone to get a loan, and well, that feels like risky lending. I know this assessment is qualitative, but in Andrew Craig’s “How to Own the World”, one thing I remember him recommending that before you buy shares in any company you go and visit if you can either a retail shop or an office and get a feel for what they place looks like. I value this qualitative assessment and based on conversations I have, there are a lot of people borrowing via Zopa who I wouldn’t possibly lend a tenner to. In addition, my loan book showed a lot of loans to be classified under “House Deposit”. I thought this was iffy and I didn’t want to be part of an unsecured tranche of a 100% loan to value arrangement. I also think no responsible mortgage underwriter would sign off a mortgage if they knew the deposit was a loan. So are these people committing mortgage fraud and lying about their liabilities on an application?

    Then I saw a throwaway comment from TEA about how p2p is effectively sub-prime lending, and this confirmed my thoughts that I was exposing my capital to a lot of risk for 4.8% growth. I know it is an incredible cash savings rate, but when the west’s debt bubble bursts or gets deleveraged, I have a feeling that all these p2p loans are going to go bad.

    So my loans are currently being sold onto another “zopian” and I am actually quite happy that I am out. So my emergency fund is now 100% cash.

  3. I experimented with p2p but gave up pretty quickly. I simply decided the returns weren’t high enough. It seemed to me one was taking an equity risk for a debt return and, as you say, in the dark as to what might happen in a crisis. The incremental return compared to a corporate bond etf or fund doesn’t compensate for lack or security.

    Taking ones risk in stocks and keeping ones cash and bonds bulletproof (and not confusing oneself as to which is which) is a good motto. P2P belong in neither category in my view.

  4. I’ve used ratesetter for 3 years and had decent returns – 6% for 5 year, 4.5% for one year and ~3% for the rolling.

    Assessing the underwriting quality is difficult and all the published KPIs are really lag indicators – it seems we will only truly know the robustness of their lending criteria when the economy/employment is tested.

    Until this morning I had 5% of my total net worth invested in the rolling accounts (some isa) – it was not as easy as I expected to request a withdrawal. T&c changed in June so that the rolling account automatically reinvests, so your Capital is only refundable subject to others capacity being available.

    To me this means the rolling/30 day account is actually much longer term lending with a right to request early payment (not a right to your capital after 30 days). Clearly this helps ratesetter manage their capital requirement as it protects any gaps in assets/liabilities (and liquidity).

    It should also be noted that the floating rate for the rolling account is set by NEW money invested into Ratesetter and not influenced by existing lenders (at roll over).

    Caveat emptor.

    B

    Ps I’m still tempted by 4% + on the 1-year loans (which feels slightly contradictory, but at least I would not be dependent on investors continued funding to get my money back)

  5. I put a few hundred pounds in Funding Circle as an experiment a couple of years ago, and consistently got about 7% back (less their 1% fee). A few companies defaulted, but the diversification was good enough that it didn’t impact my returns too greatly. When they opened up an ISA version I stuck a grand in it as I was impressed with the way it worked, and its certainly different to my other assets of index funds and equity. HOWEVER, they clearly have a supply and demand issue. My money was not reinvested and I started to accumulate a large percentage of my portfolio as cash, which of course offers no return at all. After some ‘phone calls with them I have made the decision to withdraw the cash from my classic account and basically wind it down. I’m keeping the money in the ISA (10.5% interest at the moment!)for the time being, but might just use it as a short term saving plan.

  6. In August 2015 I had 250K in Ratesetter, Funding Circle, Thin cats and Assetz. In Ratesetter I was making around 5.5%, around 9 in funding circle, over 10 in thin cats and around 8% in Assetz.

    I have lost about 1K in Ratesetter, 3K in thin cats, a few Hundred in both Assetz and Funding circle. Overall the returns were pretty good.

    Now I only have about 40K in Assetz in there monthly access account which pays around 5%, its not cash but I consider it near cash and with their provision fund I am unlikely to suffer significant capital loss.

    I pulled out because of the time it took at analyse loans and I could see the returns reduce as more people piled in and bad debts started to increase. I also pulled out because I thought interest rates would start to rise and would start to hurt the economy in general, in my opinion this would affect borrowers as they go to platforms like P2P because they cant get credit from traditional sources.

    I also pulled out because the returns are taxed at income tax rates and for me it is better to have my gains taxed as capital gains.

    Its too much a hassle for too little reward, its better to shove it into a security like fundsmith or VWRL and forget about it.

    I did however subscribe to the EIS listing for Assetz and so far that looks like it might do very well for me. I think they are well managed and likely to be snapped up in the not too distant future.

    1. Hi, small point – you said you’ve lost money in Ratesetter. How did you manage that? As far as I’m aware, no investor has lost a penny to date due to RS’s provision fund.

  7. Like other commenters, I invested a chunk across a few platforms a few years back. Returns were decent but as the platforms ‘matured’ the lending mechanisms were often ‘simplified’ to the detriment of loaners. Furthermore as more people piled in the rates dropped and bad debt on early loans started to appear. This caused me to think a bit harder about the whole thing – the people/companies borrowing the money are likely doing so because their more traditional credit lines (banks etc) won’t give them any (more) cash. Sounds pretty sub-prime to me.

    So I decided to extricate myself a few years back, I wasn’t in a rush, mostly just stopped re-investing and liquidated tranches of loans periodically. I’m pretty much fully out now, a few defaulted loan parts in Recovery aside. I’ll remember to grab some popcorn to watch the fallout when the next crash comes…

  8. Interesting… I started p2p’ing about 8 years ago with a not-a-problem-to-me sum (£1k gradually creeping upwards to £10k) and then took a more detailed look after 5 years. I carried out assorted analyses (some by professionals) on risk, asset allocation and so on, coming to the conclusion that I was under-invested in this asset class and way over-invested in property. The appearance of IFISAs was useful. So, I’m entirely happy with 6% (a 6 figure sum) allocated to this asset type, spread across a number of the more solid looking providers. Obviously I retain emergency cash and shares/bonds in the usual ISA/SIPP homes.

    Yes there are loan losses but I’ve never ended a month without a larger sum and that “gradually creeping up” looks less stressful than the assorted stock market funds. I’m not actively interested in any of this, only occasional tweaks say quarterly or annually is essential to me. I have a 6 figure sum heading my way next year assuming I manage to flog a London probate property and I expect p2p will get some of it.

    I’m a newbie here, so don’t know how many are testing p2p but it looks worth a try, for many.

  9. I equate my p2p investments to the same risk as buying single shares. I have 10500 split between ablrate (v High risk but 15%returns) and lending works (6% insurance and provision fund backed). Ablrate is hard work as Ltd borrowers but i have no more than the interest I’ve earned overall now in each BORROWER (not loan as several borrowers have multiple loans)

    In contrast i have 29k in an isa 13k in emergency cash and 150k in a pension. i would never risk a large sum in this area even spread across multiple sites .

    That said for me the returns are worth it as long as i dont get greedy

  10. I have a reasonable chunk invested in P2P (just over 15% of my total portfolio – a not insignificant six-figure sum).

    Does it make me comfortable? No.

    Do I see any alternative? No.

    My issue is that I want to have a balanced portfolio with, as an aspiring retiree, no more than 50% of my portfolio is in the stock market. I would be more than happy to have the bulk of my remaining retirement portfolio in assets generating a nice safe 3-4% but there is no such product in the market and therefore I have decided to balance the high risk / high return of P2P against ultra low-risk deposits (3-5 years accounts and premium bonds).

    As you rightly say its an industry which is relatively young and nobody really knows what will happen when there is a big downturn. In order to balance the risk, therefore, I have spread my investments across platforms and within the platforms across loans.

    I only tend to look at platforms which have only asset-backed lending (e.g. Assetz Capital, Funding Secure) or which have some degree of bad debt protection (e.g. LendingWorks) or both. The theory with asset-backed lending being that even when loans do default, you stand a good chance of eventually getting some money back provided the lender can enforce their right over the security. Of course, its a risk but I think the returns compensate for that.

    As well as asset-backed lending I also have a fair slice of money with one European platform, Mintos, which automatically buys back any loans which go bad. So far so good I am currently earning 11% and have not lost a penny. Long may that continue.

    I am expecting to keep my P2P investments at 10-15% of my portfolio and at the moment I am simply rolling over the investments. So far I don’t see a big charge for defaults but I am monitoring closely.

  11. Thank you for the great comments everyone. It’s been really interesting to hear your collective faults.

    It seems like the collective wisdom is that:
    – High returns (in excess of 10%) is reasonably possible
    – But a lot of due diligence (both platform and borrower) and actively managing which investments are made is required
    – Some platforms might auto-roll you into new investments, so you need to keep an eye out on when your investments come due and manage the flow of redemption accordingly
    – a big factor to think about is how what loans go to: is it asset backed? what processes are in place to deal with potential defaults? (asset backed having the benefit of some collateral)

    Thanks again everyone!

  12. I put in around £2.5k into P2P four years ago for a bit of diversification and because the interest rates were good. I was reinvesting all repayments and interest payments. My money was mostly in Funding Circle, Ratesetter and Lending Works, with a bit in Landbay and FundingKnight. The latter went into administration (fortunately, one of my smallest investments) and even accounting for this loss, I got around 8% returns overall.

    I was happy when the Innovative ISAs were announced but because I was unable to convert existing loans into an ISA (only new loans are covered), I decided to start withdrawing my cash bit by bit.

    Would you class property crowdfunding (eg The House Crowd, Property Moose) in the same risk category as P2P? I still have a small investment in Property Moose but am fine to leave the cash there for now.

    1. Hi Weenie, hope you had a fun vacation!

      I don’t know much about property crowdfunding. It does seem like a specialised-form of p2p. I’ll have to do some research.

  13. Great round up YFI Guy!

    I’ve got a small amount in rate setter, couldn’t resist their £100 sign up offer! Reading the above comments though I am slightly annoyed I went for the 5 year market and will be moving that over the rolling market going forward with a view to moving funds elsewhere if things start to look jittery in the economy. Haven’t looked at any others yet but sounds like Assetz could be one to look at for me.

    Also have some money in property p2p. Obviously that’s asset backed but I do have fears that the same rule applies, if there is a major crash then will investors really be able to get their money back if the property cannot be sold or is a forced seller at much lower rates than expected?

    Definitely one to play with experiment money for me, Max 5% of portfolio I reckon.

    1. @TFS
      I’ve just moved all my Rolling to 1 year, and have increased the yield from 3% to over 4.5%.

      Interestingly, the immediate access fee for one year is 0.3% (nil for rolling) – but both are dependent on liquidity of new funds.

      It’s not clear why anyone would use the rolling, especially when it now auto rolls over*

      B

      * new ratesetter Email today saying they are amending the rolling account again.

  14. @Boltt – thanks for sharing

    I just read that ratesetter email about reinstating the ability to set min rates on rolling monthly too..

    ratesetter have lost the plot a bit here it seems? they haven’t got the reward/time trade/off right – its inconsistent

    i’ll have to look into the possibility of making a similar switch, i.e. rolling to 1 year

    or more likely just dump them altogether – its taking too much attention for too little capital

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