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The peer-to-peer industry isn’t doing enough to protect investors

The abundance of peer-to-peer lenders offering high yielding loans has been getting the attention of regulators.

Many peer-to-peer lenders target unsophisticated retail investors, who can invest as little as £100. And yet, there is a relatively high cost to on-board small investors, because platforms have to handle customer calls, and anti-money laundering requirements.

There have been dozens of failures, but the closure of Lendy has shocked the industry. The high-profile peer-to-peer lender accrued more than £160m on its loan book, and by the time the administrators were called, £90m was believed to be in default.

Many firms are being supported by equity injections (crowdfunded by retail investors), but given their high cash burn, it is simply a matter of time before they too fail.

Some providers offer woefully inadequate provision funds, which give a false sense of security. When Collateral collapsed last year, it emerged that they did not have the correct regulatory permissions.

Profitability aside, there is a fundamental issue with most peer-to-peer firms.

They are just a data intermediary between borrowers and lenders, rather than a financial intermediary. They earn fees based on volume of transactions, regardless of the underlying loan performance, whereas financial intermediaries, such as banks, have obligations to repay depositors when loan investments go bad.

Without this alignment of interest, the level of due diligence performed during the underwriting process is limited, and the onus is on the investor to understand the risks and read the terms and conditions.

But many investors do not bother reading the small print, which is usually signed electronically at the click of a button. Investors are often unaware of the risks.

Clearly, more needs to be done to protect investors. Recent regulatory changes to protect investors include a cap on investor wealth in such investments.

However, minimum standards of underwriting criteria should be introduced by the Financial Conduct Authority, such as valuation methodology and borrower’s solicitor requirements, so that risks are managed.

In Germany, for example, a banking licence is required by all lending firms. Obtaining this is a more thorough process to check that the lender’s systems and staff are appropriate.

Default rates are currently artificially low, because at the end of a loan term, borrowers easily jump ship to another peer-to-peer lender eager to lend money.

Meanwhile, the shortage of good quality loan opportunities means that small peer-to-peer players, who don’t have established broker relationships, will end up lending on risky assets and borrowers.

Both borrowers and brokers are wary of the ability of peer-to-peer lenders to raise a sufficient quantum of funds within the timescales required. The weak underwriting process of some peer-to-peer firms means that they are mispricing the loans, so ultimately the investors are insufficiently compensated.

Having emerged only in the past decade, peer-to-peer firms were largely not in existence during the 2007 crisis, so like a game of musical chairs, when the credit cycle turns, no one wants to be holding the loans when the music stops.

By Vivek Jeswani

Source: City AM

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Alternative finance platforms report stellar growth

The UK alternative finance market grew by 35% to £6.2 billion in 2017, with P2P and crowdfunding accounting for 30% of all deals, according to a report by Cambridge Centre for Alternative Finance.

Peer-to-peer business lending retained the top spot, with £2 billion in transaction volume in 2017 and 65% year-on-year growth, estimated to be equivalent of 29.2% of all new bank loans to small businesses in 2017. That’s nearly double the 15.3% figure in 2016.

Consumer lending in the P2P space commanded £1.4 billion, with property lending standing at £1.2 billion and invoice trading at £787 million.

Equity-based and real-estate crowdfunding platforms also had a stellar year, with the former growing by 22% year-on-year to £333 million, and the latter hitting 200% y-o-y growth at £200 million.

But debt-based securities stagnated at £79 million, while rewards-based models decreased by £4 million to £44 million in 2017.

Institutional financing helped propel the figures, accounting for 40% of funding for P2P business lending. This trend of institutionalisation was also seen in equity-based crowdfunding, where 49% of the funding was provided by venture capital funds and professional investors “co-investing” with retail investors.

The CCAF also asked UK online alternative finance platforms to provide an indicative breakdown of their operating costs and budget allocation, finding that on average and across models, they spend about 15% on IT, 14% on research and development, 14% on sales and marketing, and eight per cent on reporting and compliance.

Bryan Zhang, the executive director of the Cambridge Centre for Alternative Finance says: “This report reflects an industry that is playing an increasingly important role in helping consumers and businesses access finance, whilst growing to become more diversified, sophisticated and institutionalised.”

Bruce Davis, director of the UK Crowdfunding Association adds: “As we move into uncertain times with Brexit discussions ongoing, the UK will need to ensure its home-grown providers of investment capital can keep providing vital investments to grow businesses and improve the UK’s productivity and international competitiveness. We hope that policy makers and regulators alike will think about ways that they can further support the growth of the industry as it matures and diversifies further.”

Source: Fin Extra

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Property crowdfunding: should you become a virtual landlord?

Property crowdfunding is becoming an ever more popular way to buy into bricks and mortar. But think carefully before putting your money in.

Many people put their money into residential property, particularly buy-to-let. But with increased stamp duty on second homes and fewer tax breaks for buy-to-let landlords, that has become less attractive. Another way of putting money into property is through real-estate investment trusts (Reits), which own commercial property assets. But the rise of peer-to-peer (P2P) lending has opened the sector to a new audience, offering potential returns in excess of the typical 5%-6% of a traditional Reit.

The biggest platforms are LendInvest, which makes bridging and development loans and has lent out some £1.4bn, according to AltFi Data, which collates information on the P2P finance sector. Landbay offers buy-to-let mortgages and has lent out £166m, while Lendy, which finances development loans and property purchases, has made more than £400m of loans.

Virtual buy-to-let

Equity-based crowdfunding is perhaps the closest thing to traditional buy-to-let investments – you buy a share in a property (usually via a “special purpose vehicle” – a company set up for that purpose) and the property is let out. You receive a share of the rental income in return, plus any profit if the property is sold. Examples include Yielders, Uown and Property Partner. A benefit of equity crowdfunding is its wide reach – it can be used to invest in line with Islamic finance principles; because income comes from rent rather than interest payments, the products are sharia-compliant.

Debt crowdfunding

Debt crowdfunding is probably the most common form of property crowdfunding today. Investors lend money, often in the form of a secured bridging or development loan, to a property developer, which builds or renovates the property and repays the investment. Many platforms secure loans on the assets, which in theory should provide some protection if the developer goes bust, although it might not be easy to sell a half-finished development in Wolverhampton, for example – and certainly not for the full price.

With property price appreciation dwindling in the capital, many platforms concentrate on the provinces, where the potential for capital growth is higher. For example, the House Crowd funds developments mainly in the north of England, and indeed builds properties itself via its House Crowd Developments arm. Another platform, the Blend Network, finances developments mainly in Northern Ireland, taking a first charge on a borrower’s assets. But when the slowdown does reach the rest of the country, you could end up out of pocket.

P2P pitfalls

One feature of P2P is that you can pick a specific property to invest in. The flip side to this is that you are making a decision on very specific local markets where you may have little or no knowledge. How familiar are you with the residential market in Chorley, for instance?

Also, consider the illiquidity of P2P compared to Reits. Platforms may have a secondary market, but it could take a very long time to sell your investment, assuming you can find a buyer. Reits have the advantage of being traded on the stock exchange, and can be disposed of quickly if necessary.

Finally, if you really want to spice things up, it will soon be possible to take fractional ownership of property using blockchain. Several start-ups are now working on platforms that will allow property owners to “tokenise” their property, and sell those tokens to investors. But if you’re not ready for the risks of P2P crowdfunding, you’re certainly not ready for that.

Source: Residential Landlord