A recent article by James Wallace, summing up an IPF panel debate titled ‘P2P CRE lending still must prove it is not the next retail investor scandal waiting to happen’ paints an unflattering picture of P2P platforms and the competence of those working there, but provokes an interesting debate about the risks P2P lenders/ investors run. As Head of Risk, I found it useful to take each of the points made and challenge them, to test whether our thesis here at Proplend holds true.
The next mis-selling scandal to happen: P2P platforms undertaking Article 36H activity (individuals lending and/or borrowing) are regulated by the FCA, although not all loan contracts making up a loan will be (i.e. corporate to corporate loans). Retail investors can choose whether or not they invest in a loan based on factual information supplied (not platform opinions). So the question is whether we prohibit individuals making a choice to invest in, say, secured commercial real estate at 50% LTV (a concept many people have some understanding of), whilst at the same time, allowing them to spread bet or trade CFDs (up to 95% gearing), or investing their life savings in emerging markets equity etc.? Giving people a choice is a generally considered a good thing, the important point is that the risk warnings are prominent and sales protocols, put in place following numerous financial scandals, are followed to the letter.
Unreliable…they are being encouraged to think can they lend themselves: Depositing money in a bank is lending, most people know that, and the fairly recent image of the queues outside Northern Rock of lenders (a.k.a. depositors) seeking repayment (in cash!) are sobering. Not only that, it’s super low return unsecured lending, albeit with the F.S.C.S. guaranteeing the first £75,000 (increasing to £85,000 next year). Retail customers, therefore, lend and borrow all the time, and what P2P does is provide product choice, competition and execution. That is why the FCA are supporting it. Capital is at risk, as it is in so many regulated products.
Fairly untested…through the other side of the cycle: A fair point on the face of it, and only one of the platforms operated throughout the last credit cycle, however, the teams managing risk will be seasoned professionals. Also, loans made by established lenders were very much tested in the past cycle, but the less said about some of those outcomes the better! It all comes down to having the right experience in the team…
Technical competence of P2P lenders in originating CRE loans: The P2P lenders that I’m aware of all hired former bankers to manage the lending side of operations. Here at Proplend, we’re a small team of 9, and 4 of us have over 80 years Real Estate Finance experience covering the entire process: origination to credit to restructuring and work out. Two former colleagues of mine, with decades of through-the-cycle experience, work at two of the bigger platforms. I myself feel a profound sense of responsibility approving a deal that will go to the platform and be picked up by smaller, retail investors, and bluntly, if we get this wrong, our growing reputation gets trashed and our business will close. The panellists quoted were likely making a point about the eye-catching marketing, sales and IT aspects of P2P, but worry not, there will be grumpy risk professionals somewhere behind the scenes making sure the lending is done properly. And if there aren’t, the FCA are bound to do something about that platform. In addition, platforms often use institutional money to underwrite and fill a new loan, providing added comfort that another set of eyes has underwritten the credit. But remember, the final credit committee for all these deals are the retail and corporate investors that push the button to invest. P2P lending should always be about only lending to borrowers, sectors and collateral that you like and want to lend to.
Reputational contagion: I think this is a really good point. All platforms do P2P differently and across many different products. For example, you can pick loans individually or you can be allocated a series of loans. The loans themselves might be unsecured personal loans, buy-to-let mortgages, SME loans, property development loans, property bridging etc. At Proplend, all we do is secured lending to income producing commercial real estate, yet if an SME platform or consumer platform gets into difficulty through bad lending, the ripple effect will extend beyond just that particular loan product. That is why platform construction is so important. What happens if the platform itself ceases trading? At Proplend, any investor un-lent cash is held in ring-fenced client money accounts held with a rated bank, plus we have back up servicing arrangements in place, so that lenders are protected in the unlikely event that our platform ceases trading. In terms of debt recovery, that comes down to the competence of the team again, quickly evaluating the options available and executing the best option for the benefit of all the lenders.
Comparable vulnerabilities between P2P lending and CMBS: CMBS involved the packaging up of pools of loans by investment banks, tranching the risk, turning them into rated bonds and selling the resultant securities to institutional investors. Poorer quality loans were knowingly packaged up with good loans on the basis there was huge appetite for loan product, and banks underwrote credit risk to sell not to hold. Those securities may have ended up in your pension, but the chances are you had no cognisance of it. With P2P, investors should be making their own lending decisions and living with the consequences. At Proplend, you consciously pick the loan and you pick the risk tranche you wish to be in.
And so it goes on:
Fee driven structure: At Proplend we charge lenders 10% of the interest they earn, when and only when we collect that interest from a borrower. As a platform, we are highly incentivised to ensure we only originate credit worthy borrowers who will make their monthly interest payments and ultimately repay the loan.
(No)…effective controls: P2P is an FCA regulated industry
(Never operated in) a high interest rate environment: I for one recall Black Wednesday and 15% base rate, but is anybody calling that out now in the Brexit, Trump era of uncertainty?
In conclusion, what this article shows is that there is a lot of misunderstanding about how P2P works. It’s a small, but growing part of our economic landscape and it won’t be for everyone. Some lending decisions will inevitably go wrong in the same way that some bank lending decisions went wrong and will continue to go wrong. Capital will be lost in some cases, but nobody is saying that it’s a risk free near cash product. But if lenders adopt a portfolio approach and spread their investments, it provides attractive, sustainable risk adjusted returns, complementing higher risk products.
As Lord Turner, previously a P2P sceptic, said recently: “[P2P platforms] might in some cases be able to do it [credit underwriting] better than banks, and they can certainly in many cases do it at least as well, while providing better customer service”.
With banks pulling back from some lending activity, such as small ticket commercial real estate, Proplend’s speciality, it’s reasonable to say that P2P provides a useful economic service to investors and borrowers alike, and is to be encouraged.
Andrew Pinfield
Proplend is a Peer to Peer lending platform for sub £5m commercial real estate debt. See www.proplend.com for more details. Investor capital is at risk. Andrew Pinfield is Head of Risk and Operations at Proplend. The views above are my own and not a representation of Proplend or any other platform.
