Peer-to-peer (P2P) lending is beginning to see a flight to quality as the growth rate of the industry slows and weaker platforms exit the market, according to direct lending specialist BondMason.
BondMason’s Market Report 2017, a summary of the latest trends in the P2P market, shows the UK direct lending market accounted for GBP3.2 billion of lending in 2016, up 39 per cent on 2015, but down from 91 per cent growth for the same time period between 2014 and 2015.
Stephen Findlay (pictured), CEO, BondMason, says: “The direct lending industry continues to grow at an impressive rate. What we are seeing right now, and what we believe to be the reason for the slow-down, is the start of a flight to quality whereby better lending platforms outperform and evolve faster and more sustainably than weaker ones, forcing the underperforming platforms to start to lose market share and then move out of the market altogether. This is good news for lenders, for borrowers and, ultimately, for the market itself.”
Direct lending accounted for only GBP3.2 billion out of GBP100-120 billion of addressable lending in 2016 (circa 3.0 per cent).
“There is plenty of room for direct lending to grow over the long term as it is still very small in the context of the overall lending market. This is exciting news for retail and institutional investors alike: competition is raising platform standards, while the growth potential for the market as a whole means that there remain great opportunities out there for investors,” says Findlay.
The report also shows that volatile stock markets and declining returns on go-to investment products has led to a migration of retail investors moving into direct lending in the search of a middle ground between high risk and low returns. Over half of wealth managers would now recommend direct lending as an alternative to mainstream cash products.
At the same time, institutional investors now account for more than half of the capital flowing into direct lending for the first time since the industry was created over a decade ago.
Findlay says: “More and more investors are turning to more passive investment services – such as ‘autobid’ services and listed direct lending funds. This places reliance on experts to filter loans (and platforms), accelerating the shift to institutional capital.
“We predict that direct lending will soon become a pension-grade investment product, as more and more institutional investors take advantage of this growing industry. This makes direct lending a real game-changer for the future of pension provision, in an environment where everyone is searching for a way to make their money work harder for their retirement.”
A significant problem with direct lending currently is the governance within the industry, Findlay says: “Regulation doesn’t guarantee the quality of a platform. When investors are looking to deploy capital across P2P platforms, FCA authorisations will serve as a ‘badge of trust’, but just because a platform is FCA regulated that doesn’t guarantee good loans or good returns to lenders.
“We look forward to continuing to support the FCA and hearing the outcome of their review into direct lending later this year, but frankly, regulation should not be relied upon to protect the industry. It requires market participants to do their bit to ensure the highest quality and a responsible attitude towards investors and client money. At BondMason, we work together with the leading players to develop best practices – we’d like to see the same with other providers.”
Consolidation between direct lending platforms and traditional financial players is predicted for 2017 as the market moves from an opening to scale phase. According to BondMason, tie-ups between direct lending platforms themselves will come later down the line, as growing infrastructure systems and improved regulation will move the relatively nascent industry to a more established means of lending.
Findlay says: “There is still so much potential for the direct lending market. We expect to see this “flight to quality” really take off over the next one to two years and for increased competition to lead to notable platform failure as it becomes harder for platforms to sustain revenues to cover their cost base.
“Furthermore, the range of investors and the methods of investing will diversify, competition and consolidation will continue to produce better products, and regulation will improve as the industry becomes more established.
“Direct lending is here for the long-haul and we expect it to evolve and change form over the coming years – becoming an ever-increasing component of asset allocations for retail and institutional investors.”