The U.K.'s rapidly growing peer-to-peer lending sector needs to clean up its act and put an end to lax standards and risky practices, according to both the regulator and critics from within the industry.
P2P firms have the potential to be an important part of the funding mix in the U.K., especially in the areas of housing development and small business loans, experts say. But, with default rates growing, the sector as a whole needs to do some soul-searching about governance and appropriate levels of risk if it is to thrive.
The Financial Conduct Authority wrote to the heads of 65 British P2P lenders, warning them to put an end to inadequate disclosure of information and poor record keeping, and to stop exposing members of the public to unsuitably risky loans, according to a report in The Times.
The letter comes several months after the collapse of Lendy Ltd., a P2P platform that allowed retail investors to fund loans to property developers. The company was reportedly put on an FCA watch list in January due to concerns about its high level of nonperforming loans and its business model.
But the market is expanding quickly. P2P lenders originated some £5.7 billion in 2018, up from £4.4 billion in 2017, according to new research by S&P Global Market Intelligence.
According to the Peer-to-Peer Finance Industry Association, an industry body, there were 155,384 active lenders and 321,483 borrowers in the second quarter of 2019 across the eight platforms that it tracks — CrowdProperty Ltd, Crowdstacker Ltd., Folk2Folk, Funding Circle Holdings PLC, Landbay Partners Ltd., Lending Works Ltd., ThinCats and Zopa.
'The horse has already bolted'
Paul Sonabend, executive chair of Relendex, a P2P marketplace focused on property development, said that the FCA's recent comments, while welcome, are "three years too late."
While the FCA has focused on areas such as the risk of fraud and the wording of advertising when supervising P2P lenders, they haven't given enough attention to monitoring actual lending practices, he said in an interview.
"They left it to the market to decide on the suitability of the business plans. We were all aware that there were both incompetent and bad-faith actors in the sector," he said. "Sadly time is proving that underwriting standards may have been poor."
The FCA, which has only regulated the P2P industry as a distinct category of financial services activity since 2014, is bringing in new rules on Dec. 9 this year that are intended to prevent harm to investors. These include strengthening rules on wind-down plans in the event of a P2P platform failing, introducing minimum levels of information that platforms must give investors, and requiring that platforms make some kind of assessment of investors' knowledge and understanding of P2P lending.
The increased scrutiny from the regulator is overwhelmingly positive for the industry, but should have come earlier, Sonabend said.
"The horse has already bolted," he said.
Andrew Whelan, CEO of the Sancus Group, an alternative financing specialist, agreed that the FCA's criticism of the P2P sector is valid. For him, the most concerning thing about the industry is that many companies are poorly capitalized, he said in an interview.
Sancus' parent company, GLI Finance, had bought a stake in a P2P lender named Funding Knight, which went into administration in 2016. Having been burned by the P2P market, Sancus now provides syndicated loans with participation from institutional and high net-worth or other sophisticated investors — but no retail clients.
Whelan said that based on his experiences of P2P finance, "the business model is dead" and "not sustainable."
"You have P2P platforms without a proper funding line or balance sheet," he said. "They rely on the crowd to complete the loan that they have originated. Borrowers think that they have a guaranteed funding line, but they don't."
Defaults on the rise
Default rates at certain P2P lenders are ticking up.
At P2P pawnbroking platform Funding Secure, for example, defaults stood at 7.6% of total lending while loans in arrears were at 17.7% as of August this year.
MoneyThing, whose current £23.2 million loan book spans property development, vehicle and aircraft finance, is expecting an 8% default rate in 2019, compared with 8% in 2018 and 6% in 2017. Actual defaults in 2017 and 2018 stood at 7.7% and 6.9%, respectively.
At real estate funding platform The House Crowd, some 13.5% of loans were "currently in default" as of the end of August. This compares with 10.4% in 2018 and 19.3% in 2017.
Funding Circle, which listed on the London Stock Exchange earlier in 2019, slashed its projected revenue growth from 2019 to roughly 20% from 40% in July, citing reduced demand for loans. The platform is currently guiding for bad debts in the range of 2.1% to 4% in its U.K. business for the 2019 full year and 4.8% to 6.8% in its U.S. business.
'Positive impact'
But as criticisms of P2P lending rack up, Robert Pettigrew, director of the Peer-to-Peer Finance Association, said it is important not to lose track of the fact that many businesses in the space are "already observing the highest standards."
"The regulator has recognized the significant and positive impact which peer-to-peer lending has on the economy for lenders and borrowers, and it is appropriate that the high expectations of platforms operating in the market are explicit and remain at the forefront of the attention of those running peer-to-peer lending businesses," he said in an email.
Relendex's Sonabend also stressed that P2P lending can be a force for good.
"We provide a valuable service delivering the finance that our businesses need, whilst potentially giving savers returns that far exceed bank deposits with considerably lower volatility than stocks and shares," he said.
