P2P loans offer investors 10% returns, but what’s the problem?
In May, Sydney-based DirectMoney became the only listed player. However, it calls itself a hybrid of market lender and traditional balance sheet.
Melbourne-based MoneyPlace started lending in early December and New Zealand-based Harmoney was launched around 18 months ago. It is expected to start matching loans in Australia in January.
To varying degrees, all are replacing banks with individual lenders or, increasingly, with other institutional lenders.
All of them offer much higher rates of return than cash deposits, but they should because they are riskier. I
What’s the risk?
Some of the newer lending platforms like to compare themselves to bank term deposit rates.
RateSetter, which is one of only two that can accept retail investments to date, calls its lenders “savers.” However, it is not that simple.
SocietyOne co-founder Matt Symons emphasizes that becoming a P2P lender shouldn’t be equated with putting money in the bank.
“This is an attractive alternative fixed income category that should have a small allowance,” he says.
This is why most have started to accept only investments from “sophisticated investors”.
This does not disqualify self-directed super funds, if they fit the sophisticated definition: net assets of $ 2.5 million or gross income of at least $ 250,000 in each of the past two years.
In fact, SMSF represent a significant portion of investors on new platforms.
SocietyOne and Harmoney also plan to go through the onerous process of obtaining a retail license in the future.
A risk mitigation factor unique to P2P lending is that each loan is ‘split’, or split, sometimes among hundreds of borrowers, in the same way that equity crowdfunding requires only small amounts from the borrower. many investors.
However, RateSetter Australia CEO Daniel Foggo expects current returns to be as high as they get because their novelty is forcing investors to demand a premium.
Returns on RateSetter in Great Britain reached 5.9% against 9.9% in Australia.
Comparison with other investments
Assessing the risk and likely return on company stocks and property is more complex than an all-in fixed rate on a loan. The gross yields available are therefore better than P2P on the riskiest of these asset classes.
Figures from research firm Chant West show average three-year gross returns to be around 18.4% for public and private stocks and 14% for listed and unlisted properties, but only 4.8%. on the more comparable investment of a three-year bond.
However, the returns, including the costs in each investment class, do not look so bullish.
In a recent memo, AMP economist Shane Oliver said that the yields on a three-year bank term deposit were 2.7%, gross residential real estate yields around 3% and the yields on dividends were around 6% for Australian stocks (with postage credits) and 2.5%. percent for global stocks.
However, one of the major intrinsic costs of most P2P platforms is that the investor lends to an individual, not a government or a large corporation, so the risk of default should be higher over the long term. term.
However, RateSetter guarantees this with a contingency fund. This is fed by a levy on borrowers which varies according to an assessment of the risk of default.
There is just under $ 1 million, or about 5.5% of outstanding loans, in RateSetter Australia’s contingency fund. He doesn’t guarantee he can cover big losses, but in five years his UK parent company hasn’t had to dip into his fund, which is close to £ 1 billion.
However, rivals say this means the returns to lenders will be lower and obviously adds costs to borrowers.
Shared cost reductions
The removal of people and bricks and mortar seems to be one of the main reasons P2P lenders can offer high net returns.
To earn the current one-month annualized rate of around 3.8 percent at RateSetter, the cash in a term deposit would have to be locked in for at least five years and the best rates would struggle to hit 3.5. percent.
However, as long as you deposit your paycheck each month, some online savings accounts offer comparable interest rates. But banks haven’t matched the long-term rates of P2P lenders.
The ever-increasing cost of software and Internet bandwidth, combined with the exponential growth of publicly available personal information, means that it is possible for machines to automate much of the banking risk assessment processes at much lower costs.
More importantly, P2P lenders don’t use their own balance sheet. Not only do they remove all brokerage and fund manager fees, which lower returns and increase lending rates, but they don’t earn a margin on the loan.
Instead, they charge a fee, which ranges from a fixed and one-time fee to a few percent of the amount. However, these can accumulate.
Harmoney, for example, charges borrowers an additional NZ $ 375 and NZ $ 375 for each “top-up” on a loan. It also charges 1.5 percent to lenders and a combined sales commission and management fee of 35 percent on the “payment protection” insurance it sells to borrowers.
So far, O’Brien has loaned up to $ 450,000 through SocietyOne, including $ 150,000 to agribusiness, and believes that compares favorably to real estate as an investment.
“I have managed funds, including real estate, and obviously did well with the property. But you don’t get the same return because there is a lot of risk and cost involved in real estate.
Like all new lenders, Foggo does a lot of transparency with RateSetter.
Its website displays data such as average yields, loan rates, total amount loaned versus applications, average loan size, default rates, and loan uses.
“We just released our entire loan portfolio. For all of the major UK and US platforms, you can see loan returns since inception, ”he says.
SocietyOne started doing the same in December.
They say time is money, and one of the big costs for lenders in the market is that it can take some time for borrowers to be matched with lenders.
O’Brien says it took about three months for his money to be invested through SocietyOne, although it may now take a few hours.
However, on average, it can still take a few days.
ThinCats is one of the few P2P lenders serving business, although several lenders who started out with personal loans now also offer business loans.
Australian ThinCats chief Sunil Aranha says the company doesn’t pretend to be fast.
It takes up to five weeks for investments, but it’s faster than many banks.
ThinCats targets investments of between $ 50,000 and $ 2 million and requires a guarantee via a “fixed and floating charge” on the assets of the company and personal guarantees of the directors. He doesn’t need borrowers to put their family home as collateral like all banks in Australia do, but he will take a second mortgage.
“We lend for two to five years to finance the growth of small and medium-sized businesses,” says Aranha. “We are quite different from the new lenders on the balance sheet of SMEs. We don’t earn a spread [interest margin], we charge a fee and we are the only ones not looking to provide money tomorrow. ”
The hybrid claims to be the future
Australia’s only publicly traded lender, DirectMoney, which launched in July, says it chose to be a “hybrid” between established and new to avoid what it sees as a big P2P loophole: ‘uncertainty about the match of borrowers and lenders and, just as happens in sharing markets, the “crowding out” of retail investors.
CEO Peter Beaumont, a former banker who worked at Citi, UBS and ABN Amro, argues that the major P2P lenders in the United States – LendingClub, Prosper and Avant – have switched to the DirectMoney model because it guarantees instant loans and puts set up segregated funds for institutional and retail investors to subscribe to these loans.
“The pure P2P model of retail ready to retail; the problem is, you never know when this deal will take place, ”he says.
“DirectMoney has managed to get around this problem by creating a loan warehouse.”
The main difference is the warehouse rotation speed. A small number of loans are made up to around $ 10 million and sold to one of two investment funds. Investors can then buy into these funds, with interest payable to the investor.
The warehouse is recorded on DirectMoney’s balance sheet for a short period, during which it receives the interest paid.
However, the competitors disagree.
“DirectMoney has not been clear on what they are; as a balance sheet lender, you are very different from a lender in the market,” says Stuart Stoyan, founder of MoneyPlace. “They’ve been holding loans on the balance sheet for over a month. The risk is that at some point you are competing with your investors.”
It is appropriate that institutional investors, such as high-frequency traders in a sharing market, have ‘jumped over’ retail investors in some of the more established P2P lending markets in the United States due to their greater capacity. assess risk and offer better rates.
To solve this problem, the biggest P2P lender, LendingClub, which has matched more than $ 11 billion so far, has set up two marketplaces. One allows investing in whole loans, which institutions favor, and another splits the loans. Loans are randomly selected to be sent to each platform based on the borrower’s social security number.
MoneyPlace does this by simply disallowing queue skipping.
“The first money in is the first money out and we allow equal access to retail and institutional investors.”
However, the big question that must arise in the mind of every investor is: Will the P2P lender you are putting money on exist when your loan expires?
Foggo is convinced that there are too many lenders in the market in Australia.
Like a shared market, most require high volumes to get the best speed and prices.
In Britain there are only two significant P2P personal lenders – RateSetter and its predecessor, Zopa. In the United States, Morgan Stanley has counted 100. But there are only three to note: LendingClub, Prosper and Avant.
In Australia there are at least six.