What next for peer-to-peer? We investigate the coronavirus impact on P2P lenders and borrowers

Two key peer-to-peer platforms have temporarily stopped lenders from selling their loans as the financial fallout of the coronavirus intensifies. Moneywise investigates how the pandemic is affecting peer-to-peer and looks at the outlook for people with money invested.

In early April peer to peer platform Lending Works introduced a 90-day ‘normalisation period’: it is not issuing any new retail-funded loans and has suspended its secondary market, meaning current investors will temporarily be unable to sell their loans if they want their money back.

This was quickly followed by Funding Circle, which provides loans for small businesses, suspending its secondary market. Lisa Jacobs, UK managing director says: “We have introduced a number of measures to protect investor returns on the platform, including pausing the secondary market while we continue to assess the impact of Covid-19.”

For savers struggling to get a decent return on their savings as well as those who are anxious about investing in the stock market, P2P has been presented as something of a win-win in recent years.

By cutting out the middleman – the bank – borrowers (who might be individuals or small businesses) are able to get a better deal on a loan while investors with money to spare are able to earn a higher rate of interest than they would with a savings account.

Zopa, which launched in 2005 and is the longest standing P2P platform, is currently promoting projected annual returns of between 3.4% and 5%, rising to 6% if you are prepared to lend some money to less creditworthy borrowers.

Ratesetter – another well-established platform – meanwhile is offering 3% a year for investors that want fee free access to their cash, rising to 3.5% and 4% with a 30- or 90- day loss of interest when you want your money back.

“Ratesetter has delivered healthy, steady returns of around 3-4% - in contrast to the volatility of stocks and shares and the near zero returns of cash,” explains the platform’s head of communications, John Battersby.

Lending Works promotes projected returns of up to 5.4% a year.

The inherent risk when you lend your money to another individual or business is that the borrower may miss a repayment or worse default on a loan.

However, before borrowers had even had the chance to fall behind on their repayments, platforms reported a surge in the number of lenders, concerned about the impact of Covid-19 that wanted to get their money back.

Neil Faulkner, head of research at specialist P2P research analyst 4th Way, says that no individual or business hasn’t been impacted by Covid 19 and the P2P lending business is no different.

Commenting on the move by Lending Works he says: “Lending Works wants to get ahead of the game in the event that the pandemic causes substantial additional defaults. It has responded to unprecedented times with unprecedented actions by pausing both new lending and loan sales for 90 days and diverting investor interest to its Shield fund.

“A sizeable minority of investors wanted to sell their loans early over the past few weeks, and the scale of any uptick in bad debts that the Shield will need to cover is not yet known, especially since Government promises that consumers will be taken care of have not yet been proven. Borrowers with temporary cash flow issues also need to be looked after with payment holidays. Lending Works' actions therefore seem proportionate and prudent.”

Some platforms including Zopa, offer loans to individuals, others, like Funding Circle lend to businesses, while Ratesetter invests lenders’ cash in both. There are also a number of platforms specialising in property, like House Crowd. Others such as Abundance are more niche. It provides loans for green and socially-conscious projects including wind turbines and solar panels for schools.

Figures supplied by Zopa, suggest that in the market’s 15-year history, £17 billion has now been lent in this way.

In 2016 the government gave peer-to-peer lending it’s ‘stamp of approval’ with the launch of the innovative finance Isa, enabling savers to hold their P2P investment in an Isa.

For income-hungry savers, it has looked like a tempting proposition. The dangers have come, however by comparing a P2P investment with a savings account. In addition to not offering instant access to your cash, your money is also not protected by the Financial Services Compensation Scheme.

Long before the coronavirus outbreak, the Financial Conduct Authority expressed its concerns about the risks posed by P2P. After consultation, it last year imposed new limits restricting the total amount of money P2P investors could hold in an innovative finance Isa to just 10% of their investable assets – unless they have sought independent financial advice.

As the actions of Lending Works and Funding Circle have confirmed P2P is a significantly higher risk than a saving account and Covid-19 looks set to be a true test for the sector.

As platforms cannot, of course, call in loans from borrowers, when a lender wants their money back before a loan has been fully repaid, it needs to sell that loan on in its secondary market to another investor. Faulkner, at 4th Way explains: “Depending on the platform that would normally take anything from a day to a week. Now it’s taking weeks.”

Before it suspended its secondary market, Lending Works reported that as many as 7% of its investors wanted to call in their loans.

At the end of March, Zopa also admitted it had received an increase in requests from investors wishing to cash in loans, however stressed it hasn’t had to suspend its secondary market. Natasha Wear, CEO of the platform explains: “Whilst at the start of the coronavirus crisis we saw an increase in demand from investor requests to withdraw money, over the last week this has significantly reduced, and requests are now line with historic norms. There continues to be stable demand to buy loans, and therefore we will be able to process most of the secondary market sale requests in the coming weeks.”

Faulkner says that any delays in reuniting lenders with their money acts as a sage reminder of the inherent risks in P2P and the dangers of expecting it to behave in the same ways as a cash account.

 “There have been a lot of irate customers complaining that they haven’t been able to get their money back instantly, but this isn’t an investment that offers high liquidity.  When you lend money as an investment it should be for the length of the loan,” he says.

The problems in the market at the moment have been the result of actions by worried lenders, rather than struggling borrowers. What will happen going forward will ultimately depend on their ability to repay loans and the ongoing efforts from platforms to mitigate those risks.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, is not optimistic. “Many of the risks associated with P2P intensify during difficult times, and the coming months could be some of the most difficult in living memory. The market is relatively immature and has not been tested in any way that approaches what we’re facing at the moment, so we have no idea how the products and indeed the companies themselves will fare.” 

“With so many people facing at least a 20% drop in their income – and many facing much more – there’s a huge risk that people with previously excellent credit records will default on their debts. If large numbers do this, there’s a real risk that not only do you not receive the target rate you are expecting, but that you could actually lose money.”

Martin Bamford, a chartered financial planner at Informed Choice is also sceptical. “There’s a real temptation to move away from cash with interest rates at a record low and scary investment market volatility. We are almost certainly heading towards a recession in the next year, if not a period of economic depression.”

“We’re already seeing widespread job losses, despite the package of financial support offered by the government. It’s carnage out there and those who took advantage of P2P lending will be amongst some of the hardest hit.”

So what happens to P2P investors’ returns when borrowers miss payments?

Different platforms have different ways of mitigating risk for their lenders.

Central to all is a thorough assessment of the risks posed by the borrowers themselves before loans are granted.

Battersby at Ratesetter says: “Similar to banks, we only lend to creditworthy borrowers, and our portfolio of consumer and business loans provides diversity.”

Zopa says it only approves around 20% of the loan applications it receives.

Platforms may also diversify your risk by divvying up your investment and lending it to a variety of borrowers. Zopa, for example, will not lend more than 1% of your investment to one person. An anticipated level of missed payments and defaults will also be factored into projected returns – so occasional blips won’t impact lenders.

Ratesetter, meanwhile, has its own Provision Fund to support investors. Battersby explains: “Every borrower pays into the Provision Fund which acts as a buffer if a borrower misses a payment. The Provision Fund model means it’s the performance of the whole portfolio that matters, as opposed to the performance or just one or two borrowers.”

Currently the fund is able to cover 1.25 times anticipated losses and to date

no lender has lost a penny but Battersby stresses it’s not a guarantee. “RateSetter is an investment, not a savings account, and capital is at risk,” he adds.

Lending Works operates a similar contingency fund called the Shield.

Following the outbreak of coronavirus, platforms have also stepped up their risk controls, not only to protect investors, but also to look after their borrowers.

“In this unprecedented climate we are supporting our borrowers, for example with breathing space arrangements which help keep the loans going,” says Battersby at Ratesetter.

Should defaults increase to such an extent that there is not enough money in the fund, Ratesetter says investors would be called upon to top it up. This would be facilitated by reducing the rate of interest they earn.

Zopa, meanwhile, says it has adjusted its lending criteria. Wear at Zopa says: “We have been tightening our credit criteria for some time, including two rounds prior to the coronavirus outbreak. We have since made further significant changes to our credit policy as well as our affordability assessments. This is both to protect our investors and take a responsible approach towards borrowers at this uncertain time.”

 “Based on the changes we’ve made, we expect that new lenders will earn the latest target return if they approach our products as a mid to long term investment and keep reinvesting turned on in their account.”

“Zopa’s product was one of only a few asset classes that generated positive returns to its investors through the last financial crisis,” says Wear. “We saw a dip in returns at the height of the crisis in 2008 when our default rates went up, but we still generated positive returns that year. The average return for loans originated in the years 2007, 2008, and 2009 was 5.1%.”

Faulkner, at 4thWay, is confident the market can survive a recession, noting that in its, albeit short, history P2P is yet to have a down year. “Looking at the market as a whole it has shown good profits year in year out.”

Faulkner does, however, acknowledge that the sector is facing its biggest hurdle yet.  “Each recession is different and it’s very difficult to predict what will happen, but we think lenders who see out the length of their loans should still see a profit.” So, while existing lenders may see a reduction in the rate of interest they earn, he is not, at this stage, concerned about capital losses.

For new investors, the risk should, theoretically, be lower. “Those borrowing now will have the risk priced into the loan.”

Few would argue that the risk profile of P2P hasn’t increased since coronavirus rocked our world. The question of whether that risk is too high will come down to individual investors and their understanding of the asset class.

Faulkner says that just like stock market investors, investors in P2P need to diversify and commit for the long term. “It’s best to diversify and lend across several accounts with loans to hundreds if not thousands of individuals and businesses to spread your risk. It’s also good to have cash and stock market investments in the mix.”

“Investors also need to be patient and see out their loans,” he adds.

But perhaps most importantly savers need to understand that P2P cannot and should not be compared to savings accounts, both from a risk and liquidity point of view.

Coles adds: “When interest rates are so low, people will naturally be hunting for higher interest elsewhere, and many will see the target rate on P2P investments and be tempted. But before you go anywhere near P2P you need to appreciate that it’s radically different to savings. It’s a high-risk investment, so if you want risk-free savings, P2P is completely the wrong approach for you.

Savings may not pay the most appetising of interest rates, but with easy access you know your money is there when you need it. As Faulkner says: “Money lending is not for people who need their money back instantly.”

Questions to ask before you invest in P2P

Each platform operates differently so it’s important to make sure you understand your chosen platform before you invest.

• Who are you lending to, individuals, businesses or both?
• Are you lending to individual consumers or businesses or a portfolio of borrowers?
• What will happen if borrowers miss payments or default – what does your platform do to protect your investment?
• If you need your money back will you have to pay a fee and how long will it take?
• What action is your platform taking to support borrowers and lenders during the coronavirus crisis?
• What will happen to your loan repayments? Will they be paid direct into your account or will the money be reinvested into new loans. Most platforms will give you the choice.

Returns for Zopa lenders over the last 15 years starting with £1,000 in march 2015:

*Blended Zopa return based on the entire book – individual investors returns could vary based on product invested, individual matching, etc.