How peer-to-peer lending has changed in 2020
In the not too distant past, peer-to-peer (P2P) lending was seen by some investors as a way to fund (and earn interest from) loans at any time, at any size, at any investment grade and at any interest rate.
If a borrower was willing to accept or be "matched" with these loan terms, P2P investors felt that if this was a risk each party was prepared to take - end of story.
What's not factored into this scenario is the intermediary, the P2P lending platform, which makes these loans and investment transactions happen. The platform must comply with ASIC's responsible lending requirements and this means reviewing whether the loan is suitable for the borrower (that is, can they afford to pay?) - an outcome that arguably suits investors in the long term.
This, combined with tighter lending criteria at all financial institutions, has reshaped the way Australia's P2P lending market looks and operates in 2020.
John Cummins, SocietyOne chief investment officer, says this P2P scenario unfortunately creates an investment bias where investors would only source the "best" or highest-paying loans on offer. In this case, an investor couldn't have more than one or two of these loans in their portfolio facing delinquency because they'd start to lose capital.
"If I give them [the investor] an average loan size of $20,000 and I give them five loans, then one goes down - not only are you not getting any money [from that loan], you're starting to lose people's capital," he says.
Since its beginning in Australia, SocietyOne's P2P lending product has remained in the realm of self-managed super funds and wholesale and institutional investors - those with gross income of $250,000 for each of the past two financial years or net assets of at least $2.5 million.
However, the lending platform has always planned to offer its P2P product to smaller investors and Cummins says this day is near. To onboard smaller investors, it will use a pooled trust where they can buy fractions or units in the trust rather than fund entire (personal) loans.
The idea behind pooled trusts is to pay a solid coupon to investors throughout the life of the loans. And SocietyOne is by no means the first P2P lender to do this.
Chris Morcom, director and private client adviser at Hewison Private Wealth, cautions investors to learn the difference between pooled and contributory trusts, particularly when it comes to P2P lending in mortgages.
He prefers contributory trusts because each client has a defined account/mortgage allocated to their investment. They're only exposed to the mortgages they're invested in, which brings a great deal of transparency.
A downside is that they don't get the breadth of loan coverage that a pooled trust would have. And if one borrower defaults or applies for hardship, there'll be no income, whereas a pooled trust can possibly cover this cost because it's dealing with hundreds and possibly thousands of loans in the one product.
Minimising the risk
To help monitor the default risk, Morcom says he'll limit investments to a loan-to-value ratio (LVR) of up to 67%. "We will not touch a secured first mortgage with an LVR of 67% or above. In fact, it will often be lower - between 50% and 60% gets a much greater amount of scrutiny from our investment committee.
"That's conservative. We don't want to lose capital in this part of the client's portfolio and [lose] a reliable cash flow. The shares part of the portfolio is meant to be the volatile bit.".
La Trobe Financial, one of the longer-running P2P lenders in Australia, says the maximum LVR you will encounter is 75%, and its portfolio has an average of 58.7%. Chris Andrews, chief investment officer at La Trobe, says the LVR cap "provides a considerable margin of safety for investors in the event that the borrower experiences difficulties in making repayments. It also means that the borrower has a substantial equity stake at risk in the loan. This is what is meant by 'skin in the game' and it ensures that the borrower's interests are aligned with those of investors."
The COVID-19 effect
Plenti, formerly RateSetter, is a P2P lending platform that still runs the traditional lender/borrower matchmaking model. Aside from the name change, the platform has recently curbed its offering to address interest rate volatility and make the market more attractive to borrowers.
In the first three months of 2020, as an investor you could still attempt to seek out Plenti loans with double-digit interest rates. Once the pandemic started, though, the platform tightened its credit criteria and dropped the maximum rate that investors could offer.
At the time this was a temporary move. It combined with a reduction in demand as personal loan volumes declined. However, renewable energy and car loan volumes remained strong.
Daniel Foggo, chief executive at Plenti, says the platform did see an above-average increase in investors wanting to withdraw their investments at the start of the pandemic. But this stabilised quickly.
"It is only natural for people to want access to funds when there's uncertainty, and our early access transfer feature allowed many to access their funds," he says.
Come July, and for the first time since it began originating loans in Australia, Plenti capped its maximum interest rates (see table).
Foggo says the move to cap maximum rates gives more opportunities for investors to fund loans to creditworthy borrowers.
"The more competitive the interest rates we offer, the more prime borrowers we can attract," says Foggo. "We consider the current maximums deliver attractive risk-adjusted returns and can play an important role in a diversified investment portfolio."
As at July 31, if a Plenti investor placed $20,000 in the 5 Year Income market, they would earn more than $7000 in interest by the end of the five-year period, says Foggo.
"Lower-rate maximums reduce rate volatility, which in turn helps us to provide our early access transfer feature to those investors that may need to access their funds," he says.
Despite these headwinds, in aggregate there's a record number of funds on the Plenti platform.
"Our renewable energy lending has achieved record volumes during the pandemic. While people are at home more and have the time and bandwidth to sort out their finances, they are looking at opportunities like installing solar panels to save money over time," says Foggo.
Both Cummins and Foggo say that car loans are above pre-Covid-19 levels. This is put down to people not travelling on public transport, as well as using the pandemic as a time to refinance their existing car loan.
Each of the P2P lending platforms we spoke to said that applications for financial hardship and requests to defer loan/interest repayments spiked between March and May, in some cases reaching as high as 8% of the total borrower book. But these levels have now halved.
Demand remains strong
Hewison Private Wealth's Chris Morcom says he's been using P2P lending as part of his clients' fixed-interest allocation for the past 25 years. "It's been one of the bright lights in our investment portfolios over that time".
He wouldn't go as far as to say there's been additional investor interest in P2P lending during the pandemic, however there's definitely more money ready to invest.
"We've now got a fair bit of investment money waiting to buy P2P loans that's built up over the past six months, which is an indication to us that there's less loans available," says Morcom.
"One of the larger providers we use said they had seen a 30% drop in their loan originations, which means less people are borrowing."
The financial adviser says this is occurring for two main reasons. There's likely to be less people being approved through tightened lending criteria or it's purely just less inquiries in a Covid-19 environment.
Because his clients' money is sitting and waiting for longer, "we're actively looking for alternatives now because it looks like it's going to be like that for a while".
La Trobe Financial doesn't involve itself with P2P products that fund personal and car loans. It sticks to its well-established knowledge base of secured first mortgages with low LVRs.
This is an important factor when investors decide where to invest. Chris Andrews says investor interest in P2P lending has grown over the past 12 months at La Trobe Financial for two reasons.
"The first reason is an underlying anxiety that investors have about market volatility and the possibility that the sharemarket in particular is overvalued," he says. "Investors are looking for investments with a less volatile capital profile that are supported by real asset [property] collateral. Our first-ranking, mortgage-secured loans at low loan-to-value ratios fit this profile neatly.
"The second reason is the challenge that investors have finding real [after inflation] income when interest rates are at historical lows. There seems to be growing acceptance that these low interest rate levels are likely to prevail for years to come. Our P2P offerings start at 6%pa fixed or variable after fees and, when coupled with our careful asset selection and management, this is an attractive offering for yield-seeking investors."
Andrews says that while P2P lending is a good vehicle for investors who want to be more active and take control of their investment outcomes, they should always remember the fundamental principles of sound investment.
"Investing on the basis of yield alone is never wise. Careful attention should be paid to all of the loan's characteristics at the time of investment. Further, by investing across a number of P2P loans, investors can diversify their holdings and so reduce their overall risk."