In this week’s post, we discuss how lenders can evaluate the different risks when lending
Peer to peer (P2P) lending gives everyone access to a pool of lending opportunities. Prospective lenders need to understand the risks and the product they are investing in. However, despite the generic term peer to peer, no two P2P products or P2P platforms are the same and lenders need to do their research before deciding which product/platform to use. According to Altfi, property lending makes up roughly 23% of the UK P2P lending market (£3 billion in a £13 billion market) and there are a wide range of peer to peer products, each sitting on a different point on the risk/reward curve. However, consumer lending still makes up the lion’s share of the UK peer to peer market (50%), while business lending accounts for 12% and receivables accounts for 16%. In essence, peer to peer needs to be seen as a tool that lenders use in order to access a pool of deals. Lenders then must choose the appropriate tool for the type of deal that most suits their investment profile.
P2P platforms can be classified according to three features:
1) The borrower (i.e. consumers vs businesses)
2) The security (i.e. secured vs unsecured)
3) The type of security (i.e. property, invoices, debenture, personal guarantees, etc).
P2P property platforms such as Blend Network are lending marketplaces where lenders can lend to borrowers who are typically property developers looking to refinance, redevelop or bridge a loan. They can be classified according to four features:
1) The level of return
2) The level of Loan-To-Value (LTV)
3) The quality of the assets (i.e. size of each unit, location, residential vs. commercial)
4) The charge (i.e. first charge vs second charge)
In order to better understand the risk/reward trade-off, potential lenders need to look at return against LTV but always keeping in mind quality of the assets and charge. In the P2P lending space, lower returns don’t always mean lower risk.
In the peer to peer lending space, lower returns don’t always mean lower risk.
– Roxana Mohammadian-Molina, Blend Network
What makes a P2P product a cut above?
Consumer-lending P2P platforms tend to offer higher yields, but the risk of loss is also higher and recovery can be very difficult. Business-lending P2P platforms taking as security the company’s cash flow are also high-risk: if the company cannot repay, you have nothing. In contrast, P2P property lending has traditionally been very popular for two reasons: 1) it’s a simple concept everyone understands, and 2) having a hard asset such as a property as collateral against a loan generally makes the loan safer and reduces risk of loss in a default scenario.
In regards to the first point, while the security behind lending to businesses can be quite complex, the hard asset behind property lending is a tangible concept. In regards to the second point, property-backed loans do provide a layer of security to the lender and help reduce risk of loss because in case of default lenders have access to a hard asset that can be liquidated to repay them. However, even with property as collateral, the safety of lenders’ money will ultimately depend on the quality of the asset.
“As P2P lending continues to develop, P2P Property lending remains an attractive option due to its relatively clear risk/return profile”
– Eddie George, Founder & CEO at NewFinance
Different P2P property platforms will be able to minimise risk of loss to a different extent depending on the LTV of their loans, first or second charge on the underlying asset and the quality of the asset – there are good-quality property assets (i.e. liquid and stable) and poor-quality property assets (i.e. illiquid and volatile). Generally, mid-value residential property is more liquid than high-value residential property or commercial property. Investors need to think of how easy it will be to liquidate the asset in a default scenario, e.g. it is easier to sell a £150k flat in a town centre than a £5M care home or a £10M residential property. The combination of LTV, liquidity and return will determine the position of each product on the risk/reward curve.
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