Marketplace lending sees record £6bn year, but growth slows as losses rise

• Total gross lending climbs by £1bn to hit £6.1bn in 2018, highest on record
• However, rate of growth has halved from 39% in 2017 as market matures and losses rise
• Demand for invoice finance and business loans key drivers of growth in 2018
• Increasing loss rates in higher risk consumer and business loans drag on net returns
• Net returns after losses and costs stand at 4.1%, down from recent high of 6.4% in 2016, but hard to beat elsewhere in the fixed income market
• Link / Brismo forecasts gross lending to reach £7.3bn in 2019, but market faces greater regulation and economic uncertainty

Marketplace lending hit a record £6.1bn in 2018, according to Link Asset Services’ inaugural Marketplace Lending Index, powered by Brismo (formerly named AltFi Data).

The value of gross marketplace lending conducted by tech-enabled platforms (which includes crowdfunded or peer-to-peer loans) reached a quarterly record of £1.6bn in Q4, up 13.9% year on year.

The record end to 2018 marks an impressive rise for this form of lending. In 2011, new gross lending amounted to just £92m. It now takes a shade under six days for marketplace platforms to originate this amount.

Nonetheless, the pace of growth is starting to slow as the market matures. Although 2018 saw marketplace lending grow at a healthy annual rate of 20.3%, this is half the pace of expansion seen in 2017 (38.7%).

Souce: Link/Brismo

The rise of invoice finance has been a key driver in recent growth, as SMEs look beyond traditional banks to finance their working capital. Invoice finance lending increased by 104.8% compared to 2017, reaching £1.1bn in 2018. Business loans, which may involve companies borrowing to invest, buy new premises, make acquisitions or refinance, broke the £2bn lending barrier for the first time, with gross lending climbing by 20.9%. Meanwhile, lending to consumers saw slower growth of 4%, reflecting a more cautious approach from consumers towards their spending.

Source: Link/Brismo

Property lending grew by just 2.1% in 2018. The challenges of the wider housing market are no doubt a factor. However, performance across the sector is not uniform. The struggles of Lendy contrasts with the solid performance of the likes of Landbay, LendInvest and Crowdproperty.

Increasing loss rates begin to take toll on returns

To build a true picture of the investment performance of marketplace loans for investors, returns must account for fees, costs, term length, and losses. After doing so, the latest available data shows net return on a typical marketplace loan stands at 4.1%. Although still an attractive yield compared to other fixed income assets, this is down from 5.4% in the third quarter of 2017, and from 6.5% at the recent peak in 2016[1].

There are two components to net returns: the net yield (which accounts for the initial interest rate and platform fees), and the loss rate on loans. Net yields have remained steady at 7.2%. However, rising loss rates are reducing the overall net return by 2.9 percentage points. This has worsened since 2016, when net losses reduced returns by just 0.9 percentage points.

There are two key factors behind this trend. Firstly, losses have risen on loans across the market, largely among riskier borrowers with higher interest rates. A weaker economic backdrop has affected the ability of a growing minority of businesses to meet the terms of their loans. Meanwhile, there is a deterioration among older consumer loans, reflecting the pressure consumer finances have been under from prolonged weak wage growth and inflation; indeed personal insolvencies reached a seven year high in 2018. Secondly, on a technical level, a smaller proportion of loans are covered by a contingency fund. These funds are designed to add additional protection against defaults, and previously flattered the figures.

Net returns may have fallen, but they remain attractive compared to other fixed income assets of a comparable term. This will continue to support demand from investors. As a result, marketplace lending is set to grow further. Link/Brismo forecasts gross lending will grow by a further £1bn in 2019, climbing to £7.3bn, representing annual growth of 20.0%.

Mark Davies, Managing Director Link Mortgages Services, said: “2018 marked a milestone year for marketplace lending as it moves into the mainstream. Platforms have started to fill the funding vacuum created by the retreat of many traditional lenders, meeting the borrowing needs of thousands of SMEs and consumers, while creating a new asset class for income-hungry investors.

“Rapid growth is also bringing tighter regulation, marking the next stage of the sector’s evolution. This will go some way towards calming investors’ nerves around rising loss rates, and but it will also encourage lenders to improve the transparency of performance reporting across the sector, allowing investors to assess risk against returns across platforms.

“However, there is no room for complacency. Increasing losses are already dragging on returns, and should we see choppier economic waters following a disorderly Brexit, this would place businesses and borrowers’ finances under greater pressure. The subsequent rise in defaults would place a new level of strain on marketplace lenders’ risk management strategies, testing their loan servicing and recovery approaches in a downturn.”

Rupert Taylor, Chief Executive of Brismo, comments: “This lending performance index reveals that an impressive risk premium has been available versus equivalent duration assets ever since Zopa emerged as the first ‘p2p’ lender in 2005. The success of this emerging capital market relies on loan originators ability to reliably attract capital to fund borrowers.

“UK platforms have been the first non-bank loan originators globally to recognise that attracting a diverse funding base relies on demonstrating accountability for performance to investors whilst ensuring that capital can be deployed based on sound analysis and an efficient process. Standardised measurement of loan performance helps to achieve this. As disclosure evolves further and gains progressively wider adoption, investors will benefit from reduced complexity and improved insight, which will further increase the appeal of these assets to a wider universe of capital providers.”