Peer2Peer Finance News July 2019 by Alternative Credit Investor

>> 6

CITY FORCES

Did institutional money hinder Trustbuddy? >> 26

GOING FOR GROWTH

Read our special report on property supported by

Growth Street’s Greg Carter talks to P2PFN

>> 12

ISSUE 34 | JULY 2019

IFISA inflows set to hit £1bn milestone The Innovative Finance ISA (IFISA) looks set to become a billionpound product, exclusive data reveals. Figures provided to Peer2Peer Finance News from the Tax Incentivised Savings Association (Tisa) show the tax wrapper has been growing in popularity since a slow start in its first tax year of 2016/2017

and as of May had attracted £764m since April 2016. There were £52.7m of inflows reported at the start of the current tax year alone. The billion-pound boost will be welcome news at a time that the industry has faced negative press and regulatory scrutiny. The collapse of property

P2P platform Lendy has led some to question the safety of the sector, while the Financial Conduct Authority announced last month that it was pressing ahead with marketing restrictions and appropriateness tests, to be introduced from December. Tisa’s data is based on 90 per cent of the IFISA market and includes

figures reported on a monthly basis by big names such as Zopa, Assetz Capital and RateSetter. Funding Circle is not included in the statistics but industry sources are confident that its IFISA intake will bring the overall figure around the £1bn mark. The publicly-listed >> 4 business lending

For even more peer-to-peer finance news, go to our website at www.p2pfinancenews.co.uk. With real-time news and exclusive insights, www.p2pfinancenews.co.uk is your indispensable portal into the world of peer-to-peer lending. Go online to sign up to our e-newsletters, for a comprehensive digest of the latest peer-to-peer finance news sent straight to your inbox. You can choose our weekday e-newsletter, which comes out by 7am Monday to Friday, or sign up for our once-a-week version that is sent out at noon on Wednesdays.

www.facebook.com/p2pfinancenews @p2pfinancenews

@p2pfinancenews

www.linkedin.com/company/peer2peerfinancenews/

EDITOR’S LETTER

Published by Royal Crescent Publishing

WeWork, 2 Eastbourne Terrace, Paddington, London, W2 6LG info@royalcrescentpublishing.co.uk EDITORIAL Suzie Neuwirth Editor-in-Chief suzie@p2pfinancenews.co.uk +44 (0) 7966 180299 Kathryn Gaw Contributing Editor kathryn@p2pfinancenews.co.uk Marc Shoffman Senior Reporter marc@p2pfinancenews.co.uk Andrew Saunders Features Writer PRODUCTION Tim Parker Art Director COMMERCIAL Alamgir Ahmed Director of Sales and Marketing alamgir@p2pfinancenews.co.uk Tehmeena Khan Sales and Marketing Support tehmeena@p2pfinancenews.co.uk SUBSCRIPTIONS AND DISTRIBUTION info@p2pfinancenews.co.uk Find our website at www.p2pfinancenews.co.uk Printed by 4-Print Limited ©No part of this publication may be reproduced without written permission from the publishers. Peer2Peer Finance News has been prepared solely for informational purposes, and is not a solicitation of an offer to buy or sell any peer-to-peer finance product, or any other security, product, service or investment. This publication does not purport to contain all relevant information which you may need to take into account before making a decision on any finance or investment matter. The opinions expressed in this publication do not constitute investment advice and independent advice should be sought where appropriate. Neither the information in this publication, nor any opinion contained in this publication constitutes a solicitation or offer to provide any investment advice or service.

t’s a funny time for peer-to-peer lending. On one hand, the industry is going from strength to strength. As our front page story shows, the Innovative Finance ISA (IFISA) market is tipped to hit the £1bn barrier, and recent Peer-to-Peer Finance Association data showed strong growth in platforms’ lending volumes, with Funding Circle’s UK loanbook surpassing £5bn. Yet on the other hand, concerns about investor protection continue to hang over the sector like a dark cloud. Lendy’s collapse will have undoubtedly shaken some investors, particularly those who are less au fait with the variety of business models in the industry. Meanwhile, the Financial Conduct Authority’s updated rules, while ultimately a good thing, shine a spotlight on the risks of P2P investing at a time when those risks have arguably been over-amplified. An ill-timed warning about “risky” IFISAs in the final throes of ISA season was hardly helpful, while the completely unrelated collapse of mini-bond provider London Capital & Finance has put a black mark on alternative investments more generally. However, it’s nice to see that this hasn’t hindered the industry’s upward trajectory. The aforementioned data shows that both investors and borrowers are continuing to benefit from the sector in growing numbers – long may it continue. SUZIE NEUWIRTH EDITOR-IN-CHIEF

Have you signed up to our e-newsletters yet? You can receive P2P news straight to your inbox five days a week, or sign up for our once-a-week version that comes out on Wednesdays. Go to www.p2pfinancenews.co.uk for more information.

NEWS

cont. from page 1 platform – which launched its tax wrapper in November 2017 – reported £120m of inflows in its IFISA last August and is expected to reveal its updated IFISA statistics in July 2019. “Tisa has now been collecting the IFISA statistics for more than 12 months and this data shows the continuing acceptance of the IFISA amongst retail investors,” said Jake WombwellPovey, founder of direct lending investment manager Goji, who has

been working with Tisa on the dataset. “Although Funding Circle has not reported its figures, the data shows that more than 57,000 IFISA investors are holding in excess of three quarters of a billion pounds in IFISAs, so the tax wrapper's success is now undeniable.” Funding Circle declined to comment. The data shows that as of May 2019, there were 57,144 IFISA accounts, with an average of £13,367, a figure that has been increasing in

recent months. Mario Lupori, chief investments officer at RateSetter, said the positive figures would inject more confidence into the sector. “It’s important now as headlines for P2P recently have been unhelpful and misguided,” he said. “It shows this is a product that investors enjoy and are getting good value from. “This is a good round number and says the product is here to stay and will get bigger.

Innovative Finance (IF) ISA Statistics Innovative Finance Value (IF)of ISA Statistics IFISAs

“It is a compelling number that commentators and professionals in the sector can latch onto.” He said RateSetter has attracted £250m into its IFISA since launch in February 2018, and believes it is the biggest IFISA manager. “Our average IFISA balance is £11,500m which is bigger than both cash and stocks and shares,” he said. “This gives an idea of the type of investor the IFISA is attracting.”

£14,000

£900,000,000 £800,000,000

Value of IFISAs

£700,000,000 £900,000,000 £600,000,000 £800,000,000 £500,000,000 £700,000,000 £400,000,000 £600,000,000 £300,000,000 £500,000,000 £200,000,000 £400,000,000 £100,000,000 £300,000,000 £0 £200,000,000

£13,500 £14,000 £13,000 £13,500 £12,500 £13,000 £12,000 £12,500 £11,500 £12,000 £11,000 £11,500

£100,000,000 £0

£11,000 Value of accounts

Average value of accounts

Source: Tisa

Number of IFISAs Value of accounts Average value of accounts 70000

4000

Number of IFISAs

60000

3500

70000 50000

3000 4000

60000 40000

2500 3500 2000 3000

50000 30000

1500 2500

40000 20000

1000 2000

30000 10000 20000 0 10000 0

500 1500 01/05/2018

01/06/2018

01/07/2018

01/08/2018

01/09/2018

01/10/2018

01/11/2018

Number of accounts 01/05/2018

01/06/2018

01/07/2018

01/08/2018

01/09/2018

01/10/2018

01/01/2019

01/02/2019

01/03/2019

01/04/2019

01/05/2019

01/02/2019

01/03/2019

01/04/2019

01/05/2019

Number of new accounts

01/11/2018

Number of accounts

01/12/2018

01/01/2019

Number of new accounts

01000 500 0

Source: Tisa

NEWS

Bruce Davis, cofounder of ethical crowd bonds platform Abundance, which was one of the biggest recipients of IFISA money in the first year, said the lender has attracted £33m across 3,100 accounts. He said the £1bn figure helped “prove the concept” of the tax wrapper. The industry data is a vast improvement on official government figures for the IFISA. The latest HMRC IFISA data, for the 2017/2018 tax year, said that £290m was invested into 31,000 IFISA accounts, up from £36m across 5,000 accounts the previous year.

However, Mike Bristow, chief executive of P2P property lender CrowdProperty, said while the tax wrapper was a sign of strength, it shouldn’t distract from the importance of a wellmanaged platform. “P2P lending with a trusted, reputed and bestpractice platform with expertise and track record is a game changer for lender returns,” he said. “These platforms reliably and more efficiently match the supply and demand of capital, meaning a better deal for lenders and borrowers rather than value leakage covering inefficient fixed costs. “The IFISA tax shield

then is a valuable cherry on top, giving lenders further benefit of those higher returns.” Preparations for the IFISA first began in July 2015 when George Osborne unveiled the new product in his Budget. A consultation followed and the IFISA officially came into existence in April 2016, but the product hit a stumbling block as P2P platforms had to be fully regulated by the FCA before receiving ISA manager status from HMRC. Newer platforms gained authorisation more quickly than the larger firms as their operations were simpler for the regulator to assess.

As a result, many of the big names such as the ‘big three’ – Zopa, Funding Circle and RateSetter – were still awaiting full authorisation in April 2016 and could not offer the product in its first year, giving an advantage to smaller and lesserknown players. Among the first entrants to the market, Crowdstacker and LandlordInvest attracted £15.6m and half a million pounds of subscriptions in the first year respectively. The ‘big three’ gained full FCA authorisation during 2017 and had all launched their IFISAs by the end of the 2017/2018 tax year.

Innovative Finance (IF) ISA Statistics

Innovative Finance (IF) ISAof IFISAs Statistics Number & Value 70000 60000

£900,000,000 £800,000,000 £700,000,000 £600,000,000 £500,000,000 £900,000,000 £400,000,000 £800,000,000 £300,000,000 £700,000,000 £600,000,000 £200,000,000 £500,000,000 £100,000,000 £400,000,000 £0 £300,000,000 £200,000,000 £100,000,000 £0

Number & Value of IFISAs

50000 40000 70000 30000 60000 20000 50000 10000 40000 300000 20000 10000 0

Number of accounts

Value of accounts

Source: Tisa

Number of IFISA Managers 140 120 100 80 140 60 120 40 100 20 80 0 60 40 20 0

Number of accounts

Value of accounts

Number of IFISA Managers

01/05/2018

01/06/2018

01/07/2018

01/08/2018

01/05/2018

05/06/2018 01/07/2018 05/07/2018 01/08/2018 05/08/2018 01/06/2018

01/09/2018

01/10/2018

01/11/2018

Manager Count (HMRC)

Manager Count (HMRC) Manager Count (reported) Number of accounts Value of accounts Manager Count Number of new (HMRC) accounts Manager Countof(reported) Average value accounts Number of accounts Value of accounts Number of new accounts

31059

32686

80 1971 20 £12,136 31059

81 1632 20 £12,562 32686

34288

01/12/2018

01/01/2019

01/04/2019

01/05/2019

Manager Count (reported)

Manager Count (HMRC) 21 21 37993

39,499

Manager 22 Count (reported) 22 41948

43465

05/08/2018 £436,436,747

05/09/2018 £460,015,662

05/10/2018 £536,106,600

05/11/2018 £560,308,026

05/12/2018 £581,077,287

£376,919,787 1971

£436,436,747 1600

£460,015,662 1355

£536,106,600 1696

£560,308,026 1728

£581,077,287 1525

£410,605,498 1632

01/03/2019

05/09/2018 01/10/2018 05/10/2018 01/11/2018 05/11/2018 01/12/2018 05/12/201801/01/2019 05/01/2019 05/02/2019 05/03/2019 05/04/2019 05/05/2019 01/09/2018 01/02/2019 01/03/2019 01/04/2019 01/05/2019

05/06/2018 £376,919,787 05/07/2018 £410,605,498

81 1600 20 £12,729 34288

01/02/2019

86 1355 21 £12,108 37993

87 1696 21 £13,573 39,499

89 1728 22 £13,357 41948

89 1525 22 £13,369 43465

45312

05/01/2019 £599,413,613.95

88 1826 22 £13,229 45312

£599,413,613.95 1826

49576

05/02/2019 £624,754,561

89 1710 22 £12,602 49576

£624,754,561 1710

51371

05/03/2019 £652,124,324.53

91 1876 23 £12,694 51371

£652,124,324.53 1876

Source: Tisa 54808 57144

05/04/2019 £711,094,495.30 05/05/2019 £763,834,739.12 933622 23 £12,974 54808

£711,094,495.30 3622

933010 23 £13,367 57144

£763,834,739.12 3010

NEWS

Did institutional investors kill Trustbuddy? AN INFLUX of institutional capital paved the way for Trustbuddy’s demise, a former executive from the collapsed platform has claimed. The Swedish peerto-peer lender became one of the sector’s first high-profile failures when it went into administration four years ago, amid allegations of mismanagement. “There is way more to the Trustbuddy story than was ever told in Swedish media,” said the former Trustbuddy executive, speaking to Peer2Peer Finance News on the condition of anonymity. “The fact is

that Swedish media were never that interested in the small fintech start-up to begin with, but were quite happy to relay the accusations made by the president of the board towards the founder and his management group without exactly going out of their way to check facts or pose critical questions. “The real truth about what happened in Trustbuddy took place during the years 2013-2015, when fund managers in London and New York were desperate to get into Prosper and Lending Club but had to settle for Trustbuddy. The effect that this had on the

company is actually quite extraordinary.” Trustbuddy was the first European P2P lender to obtain a public listing. This allowed global investors to gain exposure to the then-nascent P2P lending space. Following the platform’s closure, a state investigation found no indications of financial misconduct. Contrary to some media reports, the platform’s portfolio was not sold at a discount from the bankruptcy estate. Instead, said the source, a group of former Trustbuddy employees decided to transfer their loans into a new legal

entity from which debt collection was reinstated in collaboration with the Swedish debt collector Alektum. “By power of attorney from other lenders they later transferred over 90 per cent of all outstanding loans to the same entity,” the source added. “Representatives from Alektum have stated that the loans are in good shape as credit controls were made correctly and that they have good hopes of collecting most of the funds.” For more on this story, see our institutional investor feature on page 18.

P2PFA looks to woo intermediaries THE PEER-TO-PEER Finance Association (P2PFA) is looking at ways of boosting distribution for members. Paul Smee (pictured), chair of the self-regulatory body, said he was keen on getting brokers and financial advisers more interested in the sector. “Some have seen P2P as a cottage industry in the past,” he told Peer2Peer Finance News. “There is a case for explaining how the sector works and how it is filling an important gap where banks are losing interest.”

While many platforms typically use brokers as a route to acquire borrowers, the financial adviser market has been harder to crack, with many advisers still hesitant to recommend P2P to their clients. Only Octopus Choice

has an established network of advisers, while others have more informal relationships. But Smee predicted the introduction of appropriateness tests from December 2019 could help boost confidence among advisers about the P2P sector. “The appropriateness tests provide a good opportunity to talk about risks and reward,” he said. “It should help advisers feel more confident and provide another line of defence for those who may be nervous about

recommending P2P.” From 9 December 2019, P2P platforms will need to carry out an appropriateness assessment that considers a client’s knowledge and experience of the sector before the platform can accept the investment. Smee said the P2PFA would help members develop their tests but warned against a standardised approach. “There would be different processes for different firms so many would need something more bespoke,” he said.

NEWS

What will the appropriateness test actually look like? IT’S OFFICIAL – the Financial Conduct Authority (FCA) will soon make it mandatory for all peer-to-peer platforms to introduce an “appropriateness test” for new investors. The purpose of the test will be to weed out any unsuitable lenders, and any potential lenders who do not fully understand the risks associated with P2P. However, opinions differ on what this test will actually look like. According to FCA guidelines, the appropriateness test should include a range of questions which will assess the investor’s understanding of the relationship between the borrower and the platform, and their exposure to the risks of P2P lending. It should also confirm that there is no Financial Services Compensation Scheme (FSCS) protection, that returns may vary and that P2P investments are not comparable with a savings account. The test should also ensure that investors are aware of the risk that they may be unable to exit a P2P agreement before maturity, even where the platform operates a secondary market. However, while this test can be presented in multiple choice format,

the regulator has warned that platforms must avoid a “tick-box approach.” This suggests that each platform will have to get creative when designing their questions. The test should be hard enough to dissuade unsuitable investors and detailed enough to ensure that those investors who are deemed suitable are truly aware of the risks involved. Wellesley is one of the few platforms to already have an appropriateness test in place, due to its status as a mini-bond provider. If a new investor fails the test twice, they are unable to take it again for 60 days. “The most important thing about the appropriateness test is that the consumer understands the risk and rewards associated with the investment decision,” says Luke Madden, managing director at Wellesley. “The whole point of the test is if we feel the investor doesn't

understand the risks they are taking then the test identifies that and they're prevented from investing. “We should remind ourselves that these products do not have FSCS protection and therefore an investor should educate themselves about all the risk and rewards before the investment decision. And if the appropriateness test helps them do that then it's a good thing.” Within the wider P2P community, the appropriateness test is being viewed as an extension of existing investor protections. Several platforms already ask new investors to disclose their annual earnings and net worth. At Zopa, where the minimum investment is £1,000, investors are told at every point during the sign-up process that “it’s important you’re comfortable with P2P’s risks”, and Funding Circle advises all new investors

to read not only its terms and conditions, but its loan conditions as well. Every platform tells investors that they are not FSCS protected. The appropriateness tests must be ready to go by 9 December 2019, and some platforms are already working on the finer details. “We have always been very supportive of the idea of an appropriateness test and over recent months we’ve led work with the Tax Incentivised Savings Association to create a framework for effective appropriateness tests,” said Mario Lupori, chief investments officer at RateSetter. “The P2P sector is very diverse, so a test which is bespoke to the platform will help investors understand the specific product that they are looking to invest in.” Other P2P executives have identified the test as an opportunity which could offer a “competitive advantage” and put P2P on a par with other mainstream savings and investment choices. The challenge for platforms will be to create a test that meets the high expectations of the FCA, without alienating prospective investors. If they can get that balance right, they could end up in a much stronger position.

JOINT VENTURE

In chartered territory

The new FCA recommendations underline the importance of financial expertise in P2P lending, says Neil Maurice, chief finance and operations officer of Loanpad

HE PEER-TO-PEER lending sector is about to undergo a major regulatory shift. New proposals from the Financial Conduct Authority (FCA) will soon require all P2P platforms to introduce appropriateness tests and strengthen or reconfigure their wind-down plans. As a chartered accountant, Neil Maurice understands this new regulatory universe better than most. Before becoming chief finance and operations officer at P2P platform Loanpad, he was a director at BDO and Duff & Phelps specialising in financial services. “I spent a number of years undertaking some high-profile investigations on behalf of the FCA into specific areas such as client money, mis-selling, compliance, governance and systems and controls,” says Maurice. “What I learned was that a good financial services business focuses on three very fundamental items: policy, process and people. If you can get those three items right, then you should be a long way towards meeting regulatory expectations.” Maurice joined Loanpad in January 2018, when the FCA was concluding its postimplementation review of the P2P and crowdfunding sector before its consultation on the proposed new rules in July 2018. “For me, joining Loanpad was about creating a simple and transparent platform

that offers investors an innovative way to invest in P2P lending whilst being aware of and managing risk to the lowest extent possible,” he says. “I think we’re now entering a period where everyone is realising that regulation is critical if not core to a P2P business.” However, Maurice adds that P2P is unique in the sense that it is a relatively new and fast-evolving sector where “new business models and entrants mean that there hasn’t always been consistency in understanding regulatory expectations.” This may cause problems for some platforms as compliance and regulation continue to take centre stage. So how does Maurice feel about the new FCA regulations? “I believe very strongly that they already reflect what is good practice in any regulated firm, and certainly

in the P2P lending market,” he says. “The FCA had a difficult job in trying to strike a balance between protecting consumers on the one hand whilst also allowing the P2P sector to thrive. “I very much welcome the heightened focus on wind-down plans,” he adds. “As a sector we are trusted to hold and protect client money so we have to plan appropriately for the worst-case scenario. We have to be able to wind down a loanbook in a calm and efficient manner.” Maurice says that over the coming months, Loanpad will be reviewing the platform’s systems and processes to ensure that they meet regulatory expectations, and he is sure that other P2P lenders will be doing the same. “If done properly, the implementation of these rules will allow investors to properly compare the risk levels for each P2P lending firm so they can choose the products that are appropriate for them,” says Maurice. “Our focus is on compliance and transparency with investors. We certainly want to feel that our investor base understands what they're putting our money into. “Ultimately, I think the new rules will be a positive for platforms as investors will understand the products offered and can adequately compare and contrast different platforms.”

NEWS

Alternative lenders embark on new securitisation deals THE ALTERNATIVE lending sector is seeing a new wave of securitisations, as platforms look to tap the debt capital markets for cash. Online property finance marketplace LendInvest completed its debut securitisation last month, packaging up £259m of UK buy-to-let mortgage loans. The securitisation was oversubscribed, indicating a strong appetite among institutional investors. Citi acted as sole arranger, while BNP Paribas, Citi and HSBC acted as joint lead managers on the deal. Meanwhile, Funding Circle is no stranger to the securitisation space. It emerged last month that the peer-to-peer business lender is readying to embark on its fourth

transaction, with Deutsche Bank mandated as arranger and lead manager. It comes after a £187m portfolio of business loans originated by the peer-to-peer lender was securitised in April, sponsored by Pollen Street Capital. Zopa has embarked on two securitisations of its consumer loans, and the P2P platform’s head of capital markets Jonathan Kramer said last year that the firm is anticipating further issuances. A report released by credit agency DBRS earlier this year predicted that securitisation will play a key role in the growth of P2P lending in the UK and Europe. “We’re seeing new marketplace lenders increasingly look towards

the securitisation market for funding,” Christian Aufsatz, managing director, head of European structured finance at DBRS, told Peer2Peer Finance News. “They see it as a profitable and efficient way of funding P2P lending.” However, Aufsatz noted that there is some caution among institutional investors due to the uncertain economic climate. “They will look at the type of loans that have been securitized and assess

whether they have previously been tested in a recession,” he added. “A lot of these platforms are quite new so they have only operated in a benign market.” Neil Faulkner of P2P research firm 4th Way said that securitisations enable platforms to free up more of their own capital, potentially to underwrite more loans. However, he warned that investors may be complacent about the risks. “The growing size of platforms, and tightening competition, will impact quality in places,” he said. “On top of that, there is always the latent risk contained in extremely high domestic and global debts, as well as ongoing systemic risks that I don't believe have been properly addressed by regulators and central banks.”

The best from the web

We round up the biggest stories from www.p2pfinancenews.co.uk over the past month • The Financial Conduct Authority’s longawaited review of the peer-to-peer lending sector was finalised, with confirmation that platforms will need to introduce an appropriateness test and marketing restrictions for investors. Platforms will be restricted to marketing to

sophisticated and highnet-worth investors, people receiving regulated investment advice, or those who certify that they will not put more than 10 per cent of their investment portfolio in P2P. • New figures from the Peer-to-Peer Finance Association showed Funding Circle’s UK

loanbook passed the £5bn mark in the first three months of the year. Zopa remains the second largest lender, with a loanbook of £4.2bn as of the first quarter of 2019. • Disgruntled Lendy investors have set up an action group to ensure they are treated fairly by administrators of the

collapsed P2P property lender. Hundreds of investors have purportedly joined the Lendy Action Group, which will aim to provide a unified voice for those impacted by the platform’s demise and will work collectively to recover funds.

@p2pfinancenews

www.facebook.com/p2pfinancenews

JOINT VENTURE

Understanding the capital stack In the second part of our two-part series, Mike Bristow, chief executive and co-founder of CrowdProperty, explains the importance of the capital stack

ECURITY IS THE MOST important factor in lending, whatever the asset class. Property is a strong, reliable and in-demand asset class which – unlike future cashflows of a business or an individual – will always have a value. Security provides a legally-binding assurance that in the event of a default, the property could be sold or refinanced to repay lenders. But for Mike Bristow, chief executive and co-founder of CrowdProperty, the word ‘security’ can obscure a significant amount of risk. Instead, he prefers to use the term ‘capital stack’ when explaining security and risk to retail investors. The capital stack represents the tiers of beneficiaries behind an asset, in order of creditor hierarchy. At the top, or the most risky element of the capital stack, is the equity. But Bristow warns that this can be a “hyper volatile” holding. “If there's a £1m asset with £700,000 of debt, then the equity value of that asset is effectively worth just £300,000,” explains Bristow. “But if the value of the asset falls by 30 per cent, then equity value reduces to zero.” Next, there is the mezzanine debt tranche and finally, at the most secure end, the firstcharge secured debt tranche. CrowdProperty solely provides senior debt and insists on holding the first charge security on every property on its loanbook. If the

loan defaults, the first people to be repaid will always be CrowdProperty’s lenders. By taking the first charge, the platform is also able to take control of the asset and recovery processes and recover capital and accrued interest on behalf of its lenders before anyone else has any rights on recovered funds. Mezzanine debt, which is sometimes second-charge secured, will only be paid after the first charge holders have recovered their capital and interest and recovery costs. “There are some important considerations around secondcharge security that render it substantially higher risk than first-charge security,” says Bristow. “Firstly it's junior to the first charge, and secondly the second charge security almost becomes equity-like in a recovery situation. The first charge holder can recover the capital plus the interest owed and the recovery fees, but the second charge is not only junior to the capital but also

junior to the interest accrued on the first charge tranche and the cost of recovery.” To date, CrowdProperty has paid back 100 per cent of its investors’ capital and interest, even during some difficult projects. This enviable track record is due to deep expertise and an insistence on maintaining its place in the most secure position in the capital stack, as well rigorous and consistent credit policies that result in average first-charge secured lending exposure of 60.6 per cent LTV of the initial purchase and 52.6 per cent loan to GDV across CrowdProperty’s five year history. However, Bristow is concerned that many P2P property investors still do not completely understand the disparity of risk that the capital stack contains. “We’ve been in property for decades and decades, so it was quite an easy decision to say that our platform will always be first charge security only,” he says. “We really understand the risks with second charge and with equity.” By relying on the logic of the capital stack and such deep expertise, CrowdProperty has managed to do what many other P2P property lenders are struggling with – deliver attractive, secured returns to investors and scale whilst maintaining their tough due diligence standards and their exceptional track record.

PROPERTY

Strong foundations

Property is an incredibly popular investment asset, but can it maintain its shine in the peer-to-peer lending sector after high-profile platform failures? Marc Shoffman reports

ROPERTY IS ONE OF THE fastest growing facets of the peer-to-peer lending sector, drawing its appeal from the nation’s love of bricks and mortar. Andrew Holgate, chief executive of fintech consultancy Equitivo, says it is seen as a safe asset that provides capital growth and income,

while lending through P2P helps overcome the need to directly buy, maintain and manage a property. “You are investing in a loan against the property where the loan is much smaller than the value of the property,” he explains. “Investors are reliant on the income stream the property

generates. There is no risk of ownership, except in rare circumstances, so there is generally no risk that you will be paying for things like repairs. “However, what you don't get is a share in the increase of the property value; that all sits with the property owner.”

PROPERTY

Of course, there is still a risk that things can go wrong. Investors are still uncertain how much of their money they will be able to recoup from property loans funded through the collapsed Collateral platform while Lendy clocked up mounting arrears for months before entering into administration in May 2019. This shows there are risks in P2P property lending, as with any investment. Platforms may market themselves as secure due to the underlying asset, but there is no guarantee that a property can be sold if loans go bad or how long a recovery will take. However, there are more prosperous platforms in the market than failed ones and most investors are enjoying inflationbeating returns. So what should investors look out for when assessing P2P property lending opportunities? There are P2P platforms for most types of property loans, from buy-to-let to bridging to development finance. Uma Rajah, co-founder of prime development finance lender CapitalRise, says there are certain risk factors that may make some types of loans less appealing to those with less investment experience or knowledge.

“Different types of property loans carry differing risks, terms and rates of return,” she explains. “For example, investing in buyto-let loans might provide a regular income but a relatively low return, whilst investing in development loans can provide a higher return but may only pay out at maturity.” Holgate highlights a particular risk in managing the liquidity for a development loan, especially if it is issued in tranches. “As an example, a facility might be £5m in order to allow a property to be developed,” he says. “However, only £1m is drawn on

Invest tax free via our SIPP or IF ISA

day one with the rest being drawn over a period as the build progresses. “The P2P lender has two options, to ringfence £5m on day one to ensure funds are there, or don't ringfence the funds but plan forwards for how the drawdowns will be funded. “Option one is expensive, as unless the borrower is prepared to pay the full interest on all the £5m then the platform has to sit on a pot of cash that isn't earning any income. “Option two then looks more favourable but here is the risk. If they take a gamble that they can raise the funds as they are required

Do you want to earn up to 10% p.a. with P2P loans secured against UK property? *

Visit: thehousecrowd.com Call: 0161 667 4264 Email: member-support@thehousecrowd.com *Legal charge secured against UK property, however property values can go down as well as up so your capital is at risk and rates are also not guaranteed. Investments are illiquid so you are committed for the full period of the loan, which may be delayed. Not covered by the Financial Services Compensation Scheme (FSCS). Please read our full risk warning.

PROPERTY

but then are unable to, the borrower can't complete the development.” Holgate says this gamble puts investors at risk, as if they are unable to fund future drawdowns and the project stalls mid-build then the investor could be exposed to losses. This, according to Mike Bristow, of development finance P2P lender CrowdProperty, is where good management comes in, as well as healthy demand from investors. The platform has surveyors who monitor each stage of the process and will only release funds once each step is complete, while rolling up interest so the loan and investors are paid at the end of the term or if the borrower repays early. “Property expertise is absolutely critical,” explains Mike Bristow, chief executive of CrowdProperty. “That might sound obvious but expertise is light in a number of platforms. By expertise, it needs to be hands-on experience of doing exactly what is being lent against – it's only then that risk is fully understood and can be actively managed through the loan lifecycle. “Deep expertise over decades of experience through multiple cycles needs to be at the heart of the business and especially the founding team, as that creates and embeds the property culture from customer services through to the investment committee and everything in between.” He says the underlying property should be covered by a first charge security that is valued based on both the loan-to-value at the start of the project and the loan-to-gross development value – which is what it should be worth once complete. “These metrics are very important to understand at the loan level and at the platform level, defining

“ Platforms must be more transparent” the resilience of the loanbook. If statistics pages do not show this, questions should be asked,” he says. Beyond security, Rajah says it is also worth asking what is at stake for the actual P2P platform if an investment goes sour. Many platforms will put money into loans alongside investors. “If management are willing to put their money where their mouth is and invest alongside the crowd,

that’s a strong demonstration of confidence and integrity,” she says. It is all very well ensuring that investors know how P2P platforms will fund and manage a new loan, but the performance of the platform’s loanbook can also provide a good indication of its health. From December 2019, as part of the Financial Conduct Authority’s (FCA) review of the P2P sector, all platforms will have to make their default and performance data more accessible. “As a minimum, when considering a P2P investment platform, investors should ensure the platform’s underlying loanbook

PROPERTY

only focuses on high-quality real estate and has no late repayments or defaults,” Rajah says. “Once they can confirm that a platform’s lending track record is good, they should be looking for full due diligence behind each of the investments on offer, and the more detailed the better.” Holgate says investors should ask or be told what a P2P platform's recovery processes are, who they use to help them and what their success rate is on recovering funds from previous bad loans. Another issue on the FCA’s review list that will give an idea of the risk for individual investors is pricing. Its review said investors should be able to access data on the rates and fees borrowers are paying, although it has not set out how this should be displayed. Many platforms agree with and already back this level of transparency. “We offer full transparency on any spread between investor and borrower rates in our investor terms and conditions and think it’s very important for investors to understand this,” Rajah says. “The rates we charge borrowers and returns we offer investors always correlate with the determined level of risk associated with any opportunity.”

Brian Bartaby, founder of commercial property P2P lender Proplend, says an investor has no way of understanding the risk they are taking if they don’t know what rate the borrower is paying. “Some platforms are paying their lenders five per cent, which a lender will assume is a lower risk investment, but the platform then lends that out at 20 per cent – that’s not a low risk investment,” he states. “Platforms must be more transparent. “We show our lenders who the borrower is, what the property is, who the tenants are and how much rent they are paying so they can make an informed decision.” All this due diligence and transparency is key, but how does the time and effort compare with other forms of property investing such as buyto-let or investment funds? P2P investors can get returns ranging from three to 12 per cent depending on the type of loan being backed. In comparison, the average buyto-let yield is between four and five per cent, according to estate agents Your Move. Investors in property funds have seen returns of 2.5 per cent over one year and 13.2 per cent over

Invest tax free via our SIPP or IF ISA

“ Property expertise is absolutely critical”

three, according to Investment Association data. Bartaby says the biggest weapon P2P lending has over other types of property investment is control. “Once you have invested in a fund or syndicate then the asset or fund manager is the one making the investment decisions,” he explains. “With a P2P platform you can either set some lending criteria in an auto-lend product or pick and choose the projects yourself.” Bristow adds that the tax system is more punitive for direct property investment as second home buyers now have to pay extra stamp duty and have seen allowances scaled back. Meanwhile, Rajah explains that property funds tend to charge higher fees and offer lower returns, while providing less detail on the underlying assets. P2P property lending is a broad church, with the onus on investors to do their own due diligence and choose the platforms – and risk level – most suitable for their requirements. However, if you are willing to put the effort in and build a balanced portfolio, it can open the door to decent returns.

Do you want to earn up to 10% p.a. with P2P loans secured against UK property? *

JOINT VENTURE

P2P, property and pensions

Frazer Fearnhead, founder and chief executive of The House Crowd, makes the case for including P2P property loans in your pension portfolio

T HAS ONLY BEEN THREE years since peer-to-peer investments were granted ISA status, but now a new tax-free wrapper beckons: the Self-Invested Personal Pension, or SIPP. The multi-billion-pound SIPP industry allows individuals to invest up to £1m within a pension portfolio over the course of a lifetime, where it will be sheltered from taxation until the investor reaches retirement. While most types of investment can be held within a SIPP, there is one notable exception: residential property. Unless, that is, you open a SIPP with The House Crowd. “With our offering, the investor is not actually purchasing the property, they're making loans to a third party developer,” explains Frazer Fearnhead, founder and chief executive of The House Crowd. “Our SIPP provider has done a lot of due diligence on us and seen the sorts of developments that we do and they are comfortable allowing their clients to invest in those.” The House Crowd’s SIPP customers choose the properties that they wish to lend to – these can be either residential homes or buildings that are still under development. Most of these loans have a term time of between 12 and 18 months, and target returns of between eight and 10 per cent. Alternatively, they can choose an auto-invest product which automatically diversifies capital over approximately 20 different

development and bridging loans. Once the loan matures, the interest and capital is returned to the SIPP pot, and it stays there until it is reinvested in the next suitable property. For many pension savers, this is an ideal solution, as they can diversify their portfolios while also accessing the higher target returns that come with the property sector. But The House Crowd is adamant that its investors should use its SIPP as a diversification tool only, and not as a catch-all pension fund. “We tend to attract older, more sophisticated investors, but we are constantly telling them not to put all their eggs in one basket,” says Fearnhead. “With the best will in the world something can always go

wrong with a particular investment and it's going to affect you a lot more severely if you've put all your money in one place.” The House Crowd is committing to this message by expanding its existing auto-investing model to three separate products so that investors can choose their own level of risk and reward. “We undertake full due diligence, even if the development is one an associated company is developing.” he says. “We do everything from checking the borrower’s background, evaluating the site, having a full RICS valuation, analysing the borrower’s exit strategy including the market liquidity and conducting feasibility studies. Our quantity surveyor will also analyse the construction costs down to the last nut and bolt. “We employ a fund manager who checks the valuations, and these are signed off by both our lawyer and our chief finance officer before any money is drawn down by the developer. We then have fortnightly meetings to go over the progress of each development.” Fearnhead believes that there is a place for property investments in pension funds, and he is clearly not alone. “People should be given a choice for what they invest in with their pension as long as they are aware of the risks,” he says. The House Crowd’s growing catalogue of SIPP investors suggests that clients agree.

INSTITUTIONAL INVESTMENT

Money talks

The rise of institutional funding in the peer-to-peer sector has been hailed as a game-changer for borrowers and retail investors alike. But does that City money come with strings attached? Kathryn Gaw investigates

019 IS SHAPING UP TO become the year of the institutional investor. Over the past few months, hundreds of millions of pounds has flooded into UK-based peer-to-peer platforms from a variety of global institutions, all seeking to access the competitive returns of a well-regulated alternative finance provider. According to the most recent figures from the Cambridge Centre for Alternative Finance, 32 per cent of P2P consumer loans and 26 per cent of P2P business loans were funded by institutional investors as of 2015, and the share of institutional money is likely to have

grown since then. This was widely viewed as being a good thing for the UK’s P2P sector. But then we were contacted by a former Trustbuddy executive who had a very different experience with institutional money. Stockholmlisted Trustbuddy was the first highprofile P2P platform to collapse, filing for bankruptcy in 2015 amid allegations of misconduct. The anonymous employee told Peer2Peer Finance News that “there is way more to the Trustbuddy story than was ever told in the media.” “The real truth about what happened in Trustbuddy took place during the years 2013-2015, when

fund managers in London and New York were desperate to get into Prosper and Lending Club but they had to settle for Trustbuddy,” the former employee said. “The effect this had on the company was actually quite extraordinary.” This influx of institutional money led to rapid growth at Trustbuddy – which was at that point the only listed P2P platform in Europe. In the first six months of 2015, the platform processed more than £10m of loans and planned an expansion into the UK market. Then in the summer of 2015, an executive reshuffle led some new board members to suspect financial

INSTITUTIONAL INVESTMENT

mismanagement. Once this became public, the company’s share price took a nosedive, a legal case was filed and the company ultimately went into administration. In May 2017, state prosecutor Ted Murelius completed his investigation by concluding that there had been no evidence of misconduct at the firm.

campaigns, while platforms have pushed consumer education and risk management to the forefront of their websites. For many of these individuals, institutional investors represent a threat to their funds. There are concerns that the size of these institutional investments could result in fewer opportunities

“ To be brutally honest, it’s easier dealing with five institutions than with tens of thousands of individuals

This story raises some serious concerns about the unintended consequences of institutional investment. Trustbuddy’s fate was sealed when it became over-reliant on institutional money, which could be withdrawn as quickly as it was invested. The Trustbuddy story is particularly relevant in the current investment environment, where institutional money is increasingly being viewed as an easier alternative to the much more complex world of retail investment. “To be brutally honest, it’s easier dealing with five institutions than with tens of thousands of individuals,” says one industry insider who asked to remain anonymous. “And if you think about what we’ve got coming up in terms of upcoming regulations, we are going to have to have all these appropriateness tests and that’s likely to involve a lot more hard work.” Influx of money To date, retail investors have been seen as the priority among P2P lenders. They have been courted with television ads and social media

”

being left over for retail investors. There is also a fear that through the sheer weight of their wealth, institutions may be able to request certain changes to the platforms’ risk assessments and credit checks. Several platforms told Peer2Peer Finance News off the record that they have had to change their lending criteria in order to make themselves eligible for certain institutional funds. “There are some drawbacks

of institutional involvement in P2P that retail investors should be aware of,” says Iain Niblock, chief executive and co-founder of Orca. “The main concern is the potential conflicts of interest that may arise, which could see institutions choosing the best deals from platforms to the detriment of retail investors. “But while there may be some concerns, growing institutional involvement, on balance, should be seen as a positive sign for the P2P sector. “Institutional involvement means more capital for lending and an increased demand for robustness in the credit and business models involved, which in turn helps to grow the sector and stabilise the businesses of the platforms. As platforms become larger and more profitable, we could also see cost savings passed onto retail investors.” It should be added that Financial Conduct Authority (FCA) regulations prevent institutional investors from selecting the best loans from consumer-focused platforms, and many P2P

INSTITUTIONAL INVESTMENT

platforms have introduced their own measures to protect retail investors from being outbid. “We will not permit cherrypicking of loans by institutions and we have a randomiser to prevent adverse selection against any investor, retail or otherwise,” says Stuart Law, chief executive of Assetz Capital. “Nonetheless there is a greater mitigant to cherrypicking risk and that is our unique marketplace which today allows retail and institutional investors to share the fractional funding of loans on pari passu terms, rather than institutions taking whole loans only.” Assetz Capital is one of the many platforms which has created its own retail-friendly model. For instance, property-backed P2P lender Loanpad employs a hybrid model of lending, which sees institutional investors take on the higher-risk pieces of any given loan, leaving the lower risk remainder for retail investors. Although retail and institutional investors are still investing in the same loans, that institutional element effectively shields individuals from the higherrisk portions of each loan. Other platforms have opted to accept institutional money specifically so that they can grow the retail side of their business and create more lending opportunities for existing users. Flender, Lending Crowd, Growth Street and CapitalRise have all accepted growth funding from institutions in recent months. And in March, MarketInvoice announced that it had secured £100m of institutional funding to enable the platform to offer larger deals. But the two biggest institutional moves of the year were made by Funding Circle and Assetz Capital.

“

We will not permit cherry-picking of loans by institutions

”

In April, Funding Circle announced that it would be launching a UK private direct lending fund and a UK bond product, with the aim of attracting more than £200m from institutional investors over the next few years. The following month, Assetz Capital launched its first Luxembourg-based private fund in order to attract more institutional money to scale up its lending. Earlier in the year, Assetz signed a series of funding agreements with

institutions including Germany’s Varengold Bank, a European family office, and an unnamed credit fund. The total value of these investments is believed to have been upwards of £110m. However, Assetz Capital’s Law insists that this institutional influx has not come at the expense of retail funds. In fact, he says, retail investors can take comfort from the fact that institutions have chosen to back their platform. “We see substantial institutional investment into P2P lending in the coming years but only into those platforms which can provide great credit quality, strong net returns as well as good liquidity,” he says. “Our growth has been very strong and now there is a lot of capacity for

INSTITUTIONAL INVESTMENT

“ It’s about making

sure that the investors understand the risk and the importance of diversification

”

institutional investment.” ThinCats has taken a similar approach. It was one of the first platforms to pivot towards institutional funding, raising more than £700m from institutions over the past two years, compared with just £100m from retail investors. However, chief executive John Mould has reassured retail investors that their money is treated no differently to institutional money, adding that they will actually benefit from the enhanced due diligence that attracted those institutions to begin with. Finding a balance For now at least, it seems that the P2P sector is managing the balance between retail and institutional

investors. According to the latest figures, cumulative lending from the Peer-to-Peer Finance Association’s eight member platforms totalled more than £10bn – and that is not representative of the entire P2P industry. Meanwhile, Innovative Finance ISAs (IFISAs) – which are only open to retail investors – are thought to have attracted £1bn. In the same month that it launched its institution-only investment fund, Assetz Capital attracted a record £13m into its IFISA funds, bringing its total IFISA investment to £90m. This suggests that there is plenty of room for both retail and institutional investors, just as long as platforms don’t get carried away

by the lure of the multi-millionpound investment. Some industry onlookers have suggested that what happened at Trustbuddy could possibly have been avoided if its institutional investors had a better understanding of the platform’s business model, and were prepared to commit their money over the long term. “Maybe the secret for all these platforms is to just pick the right type of investor,” says John Mould, chief executive of ThinCats. “Be that the retail investor who understands the asset class, or the institution that is committed to making longterm investments. In both cases, it’s about making sure that the investors understand the risk and the importance of diversification, as well as the fact that they are investing in a long-term illiquid asset.” As more and more institutional funds start to pay attention to P2P, platforms will need to be extra careful to prove that they have best-in-class credit processes, and a sustainable plan for growth which does not rely on just one or two high-profile backers. Fortunately, the vast majority of UK platforms appear to be taking a prudent approach to institutional investment, which should hopefully spur them on to their next stage of growth without alienating the individual investors who made the industry what it is today.

We build relationships with our Borrowers It allows us to mitigate, eliminate and accept risk in the best interests of our Lenders.

ArchOver has facilitated over ÂŁ100m of funding to UK businesses, having paid over ÂŁ6m in interest and delivering investor returns of up to 11% p.a.

archover.com ArchOver is authorised and regulated by the Financial Conduct Authority 723755 and is not covered by the FSCS. Lender capital at risk. Past performance is not a guarantee of future returns.

SPONSORED CONTENT

Who do you want on your team? Why institutions are turning to P2P David Swanson, head of lending at ArchOver, delves into the benefits of P2P for City investors

HEN YOU’RE looking for investment opportunities, ask yourself this: ‘who do I want on my team?’ This is as important in life as it is in business. The people around us make all the difference to our experience of life. You want the right doctor, lawyer, friends – people you connect with. Similarly, you want to look the companies you’re dealing with in the eye and see a team that you trust. Institutional investors are people too. They want to know that they’re putting their company’s capital in the right place – after all, their careers are on the line if it goes wrong. Too often the big players in finance treat the investment business as formulaic – tick the boxes, fit the bill, get the cash (or not). That’s not the right way. It excludes too many smaller businesses, and it makes it impossible to get a truly dedicated service. Let’s take a step back for a minute. Why do institutional investors come to the peer-to-peer sector in the first place? At the most basic level, it’s to get their cash working as fast as possible to achieve the highest possible returns matched with the best possible level of security. Often, though, those two variables work against each other – the higher the security, the lower the returns. The trick for institutions, then, is finding the point where the graphs converge – and where the best opportunities lie.

Institutions looking at newer investment opportunities like P2P need a higher level of reassurance and comfort that their money is safe. The tipping point with any investment is to reach an understanding where the facilitator prospers as the investor prospers, and suffers if the investor suffers. In venture capital, that means the company on the selling side puts its own skin in the game. Things work differently with P2P platforms, which act as agents rather than principals. Institutions deal with this by only entering into deals where someone else is putting in money at higher risk. That acceptance of higher perceived risk will earn higher

interest but, if something goes wrong, the company with the ‘first loss’ piece of the pie literally takes any loss first. How to choose which P2P platform to use? Institutions have to be extremely prudent about dedicating time to assessing investments. They need to understand credit analysis processes as well as individual loans. They need trust in the thoroughness of the credit process – then they can invest in a number of loans with the same confidence in all of them. Which brings us back to where we started – who do you want on your team? At ArchOver, we’re dedicated to seeing the whites of our borrowers’ eyes. Our credit analysis is detailed and thorough, and we’re continuously improving our processes. We get to know these companies intimately as individuals and understand the uniqueness of their business. We’re confident that those that make it through the scrutiny of our credit team have an extremely strong chance of succeeding. And even then, we aim to detect any point of weakness and protect our lenders against it, whether through credit insurance, dispute resolution or controlled accounts. Institutional investors are people. Borrowers are people. Personal trust is the best basis on which to build a financial relationship. Is that how your facilitator works?

Maximise your capital

Competitive fixed rate bonds Invest The Wellesley Way

The Wellesley Way

Desktop www.wellesley.co.uk

Your capital is at risk and interest payments are not guaranteed. Investment in any Wellesley Listed Bonds are not covered by the Financial Services Compensation Scheme.

JOINT VENTURE

No alarms and no surprises Luke Madden, managing director at Wellesley, was not surprised by the FCA’s revised regulations. In fact, Wellesley has made a habit of planning ahead

HE NEW Financial Conduct Authority (FCA) regulations for loan-based (peer-to-peer) and investmentbased crowdfunding platforms have been met with a wall of discussion, as firms rush to comply before the 9 December deadline. But Luke Madden, managing director of alternative lender Wellesley, is unfazed. “We were not surprised by the new regulations,” he says. “The direction of travel was clear, based on the consultation paper from last year.” In fact, Wellesley had already implemented the majority of these new compliance rules before they had even been announced. The platform had already been working to prioritise its risk management framework in preparation for December’s SMCR deadline, and many of these updates happen to be in line with the new FCA requirements. As a regulated firm Wellesley was required to establish a winddown plan and to appoint back-up service providers who could step in if the platform wasn’t able to perform its duties. Now, Wellesley has gone further by conducting an independent stress test on its loanbook, using Bank of England macroeconomic scenarios. It is standard practice among banks and insurance companies to conduct stress tests using financial modelling to look at how their businesses

might perform in a more extreme economic environment and now the alternative finance industry is starting to follow suit. Earlier this year, Wellesley hired MIAC Analytics – an independent stress testing firm – to take a look at its loanbook and credit risk policy. Wellesley provided MIAC with a raft of information on its credit policy and loanbook, as well as interviews with the management team and reams of quantitative and qualitative data. MIAC concluded that Wellesley’s loan portfolio is “expected to demonstrate resilience” in periods of extreme stress. “We were happy with those results,” says Madden. “It was a ratification of the current credit policy and the strategy that we have in place today.” Wellesley has

published the MIAC stress test on its website. “We have a robust credit policy which is regularly reviewed and approved by board,” Madden adds. “We have industry professionals appointed to our panel of valuers and quantity surveyors. We rigorously assess all of our loans, not just at the point of origination but on an ongoing basis relationships are a cornerstone of our business, so we go to extreme lengths of due diligence to ensure that our borrower relationships are sound and our investors are protected.” Madden remains positive on the ability of good regulation to strengthen the industry and protect consumer money. However, he adds that this new era of FCA scrutiny may kick start a consolidation phase, as developing firms struggle to catch up with established players. “These rules are good for the industry because they effectively raise the minimum standards which every authorised firm must adhere to,” says Madden. “I think that's a good thing from a consumer perspective.” Wellesley’s forward-thinking approach is likely to confirm its reputation as one of the more reliable and consumer-friendly platforms on the market. In the everevolving world of alternative finance regulation, Wellesley continues to look ahead and adapt to better serve its customers’ needs.

PROFILE

Streets ahead

Growth Street’s chief executive and founder Greg Carter talks to Andrew Saunders about filling the overdraft finance gap and beating the banks

HE BIG GUNS IN peer-to-peer small- and medium-sized enterprise (SME) lending have been pretty successful at opening up the price and availability of both secured and unsecured loans over the past decade or so. Now, says Greg Carter, chief executive and founder of SME lending platform Growth Street, it’s time for a new generation of P2P innovators to do the same thing for the lesserspotted business overdraft. Also known as revolving credit facilities, the supply of small business overdrafts from mainstream banks dried up almost overnight after the financial crisis and has not recovered since, according to Carter. “There is a huge gap in the availability of overdraft finance,” he asserts. “Since the financial crisis, the availability of overdrafts for SMEs has actually fallen by 43 per cent, at a time when the SME population has actually grown by over 30 per cent.” It amounts to an £18bn shortfall, he adds, and despite the rise of cheaper, faster SME loans from the likes of Funding Circle and its growing crop of rivals, flexible credit is still largely provided by banks. “The gap hasn’t been filled by any other products, there’s been a real lack of innovation in the availability of flexible credit for SMEs,” he adds. In a bid to do something about it, Carter founded Growth Street in

2014. “I saw an opportunity, and a couple of trends that would enable us to serve it,” he explains. “Firstly technology – there was more and more data available from SMEs that were using cloud accounting tools like Xero, and they were also increasingly happy to share that data through the APIs that those tools have.” Slick technology would not only eliminate the hassle for customers of having to find and send paper statements and PDFs as part of the application process, it would also enable Growth Street to dramatically reduce the cost and increase the efficiency of credit analysis, he says. “Then there was a regulatory trend – P2P was reaching maturity and had just started to be regulated, and it was clearly a very flexible

source of funding for the business. And there was the Open Banking trend, which would give us even more extremely valuable data.” Growth Street’s core product – known as Growth Line – is a revolving credit facility with a limit of between £25,000 and £2m. Approval varies depending on the size and nature of the business applying but typically takes between one to three days, says Carter. Thanks to partnership deals, Growth Street is on both the Xero and Starling Bank marketplaces and SMEs can apply via their accounts using APIs and Open Banking tools to provide the necessary information in a few clicks. Once approved, borrowers can draw down and repay any sum up to their limit as often as they wish. There is a service fee, and interest

PROFILE

which depends on credit risk, but overall costs are comparable to the regular banks, he says, and availability is much better. “If you could get a bank overdraft it would cost a similar amount,” states Carter. “Compared to a Barclay’s business overdraft the cost is pretty much the same. “It’s a very flexible revolving facility that gives businesses complete control over cashflow. They can stop worrying about unexpected costs and just get on with growing.” For investors the platform also offers advantages over regular term lending, says Carter. When a Growth Line customer draws a sum down, a 30-day loan contract is created automatically and matched with available investors’ funds. Although many

“ There’s been a real lack of innovation in the availability of flexible credit for SMEs”

people prefer to roll over their investments for continuous returns, the fact that each contract is only for 30 days should make it easier to get your money out than it is from a three-year term loan. “It’s a stable liquid investment,” Carter says. “Under normal liquidity conditions investors can withdraw within 30 days.” Returns, he says, are around five per cent on an effective basis, and the firm has just launched an Innovative Finance ISA offering 5.8 per cent for those investors wishing to commit their funds for a year rather than 30 days. “It’s early days for the ISA but take up is good so far,” he reveals. “We launched early

in the year so that we would be fully operational for the ISA season later in the year.” After a degree in neuroscience specialising in gambling behaviour, Carter joined online gambling platform Betfair before moving into venture capital at Arts Alliance – an early investor in the likes of Graze, Shazam and LoveFilm – following Betfair’s £1.4bn stock market flotation in 2010. In both roles he witnessed both the transformative power of new business ideas, and the growing pains that accompany them. “At Betfair I was in charge of new ventures, and I got hooked on how businesses grow,” he explains. “At Arts Alliance I would ask the

PROFILE

companies I was working with what was holding them back from growth. The answer that came up most often was managing cashflow.” The crux of the matter, the entrepreneurs explained to Carter, was that because their cashflow was so unpredictable they had to hold large cash reserves in order to be able to cover unexpected costs. Cash that could much more profitably be put to work in growing the business. “What they really wanted was an overdraft, but it would take their bank six months to say no,” Carter comments. “It was incredibly frustrating for them.” Happily for Carter, Arts Alliance’s founder – and Growth Street’s lead investor – Thomas Hoegh didn’t take too much persuading that the firm’s concept of “the overdraft, transformed” had legs. “He had already been thinking about disrupting banks,” Carter says. “His years as an investor and entrepreneur had taught him that banks were completely useless at providing growth finance for SMEs.” Carter concedes that there are valid reasons why banks struggle to service small businesses – the differing regulatory capital requirements make mortgages, for example, a much more appetising prospect than financing SMEs – but also admits that he was surprised to discover for himself just how difficult they could make life for a start-up with an untested business idea. “Until challenger banks like Metro and Starling came along it was impossible,” he asserts. “One of the biggest challenges we had in 2014 was that we couldn’t get a bank account. We went to lots of banks and told them the business we were building and they just said flat out ‘no’, it was extraordinary.” But even this unexpected cloud

“ We have to ensure that borrowers can always draw down, and that investors’ funds are always deployed

”

had a silver lining – Growth Street got an account in the end, but not before it had been forced down a DIY route which involved building its own automated e-money payments system. “It was very frustrating at the time but now I

am grateful for it, because we were forced to innovate, and that system is now one of our secret weapons.” Growth Street – which in January closed its first equity funding round, raising £7.5m led by the Merian Chrysalis fund – is also innovative in the way it tackles two other major issues that make revolving credit more complex to provide than term lending – underwriting and liquidity management. For overdrafts as opposed to regular loans, credit risk assessment is not a one-off but rather an ongoing process. “We spent a lot of time early on looking at how we could use data not only to approve facilities up front but also to continuously

PROFILE

“ A borrower is not

just a single transaction but an ongoing relationship

”

monitor them,” Carter says. “Since early 2017 we have had a partnership with Moody’s Analytics using one of their core products called Risk Calculator. We grade customer using data that we pull continuously from their cloud accounting platforms.” The average credit facility Growth Street provides is around £200,000, and liquidity is a challenge because of the uncertainty over when and how much of their limit any customer will be using at a given point in time. “We have invested in our own exchange technology to manage that problem, inspired by my time at Betfair,” he says. “We have to ensure that borrowers can always

draw down, and that investors’ funds are always deployed, that’s the real balancing act.” Investors effectively join a queue to be matched with 30-day loan contracts, so the volume and frequency of matches on the platform is considerable – “Hundreds of millions a year,” says Carter. To manage any blips in supply and demand, Growth Street has deals with a small number of institutional investors – typically family offices – which act as a backstop on the platform to ensure liquidity. “They are not matched very often so we pay them a standby fee,” he explains. “It helps to ensure that our deployment rates [for retail investors] are in the high 90s in percentage terms.” It all seems to work – Growth Street has signed up 2,500 investors since it opened for business and has lent out around £96m to SMEs over the same period. The average investment is £16,000, and 40 per cent of those on the platform are millennials, which as Carter points out rather goes against the prevailing narrative that younger generations don’t save. “On our platform they are the single biggest group,” he says. Growth Street also happily anticipated the Financial Conduct Authority’s ruling that investors should self-certify, and has categorised its lenders as retail, high-net-worth or sophisticated from the outset. The sophisticated

and high-net-worth categories account for around a third of investors by number, but around two thirds of funding. The rest (including that large millennial cohort) are retail investors, with average investments of £4,600 each. One unanticipated development, says Carter, is that more established cash-rich businesses are now starting to lend their own surpluses to younger, faster-growing firms via the platform. “Companies invest their surplus cash and they appreciate the flexibility – they cycle up and down according to the seasonal cash demands of their own business,” he explains. “It’s underappreciated that SMEs are actually net depositors. There is £130bn of SME borrowing in the UK, and £150bn of deposits. But those cash reserves are not evenly distributed.” Growth Street’s own business is growing fast, and it has just launched into the Scottish market, which Carter describes as having “A beautiful population of SMEs that are hugely underserved by the big banks. There’s an £800m overdraft gap there, one of the biggest in the UK.” Although he intends to prioritise overdraft alternatives while developing a substantial data asset that could be used to sell a range of financial products to SMEs, Growth Street is not all about the numbers, he adds. “We want to be a leader in the way we support our clients, not just investing in the best tech but also in strong relationship management,” says Carter. “That’s why we have built a fantastic team of relationship managers. We have a view that a borrower is not just a single transaction but an ongoing relationship – and we plan to be here to grow and scale alongside them.”