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For me Alternative Finance is the most exciting sector in Fintech by far in terms of near term impact as competition for the “Old FS” and as choice for both borrowers and lenders.
In this episode I am delighted to be joined by Christian Faes CEO of Lendinvest. In the world of Fintech froth that has been 2014 Lendinvest and Christian are the real deal.
In this episode we “kick the tyres” of P2P and have an organic conversation exploring some key angles in the sector right now. There is plenty of “linear” content out there (eg this concise YouTube explaining Lendinvest), and conference panel discussions (eg this LendIt one with Christian on the panel) – and they are all great. However as usual on the podcast I aim more for the kind of conversation that one might have with the insiders in the bar after the formal conference.
This is also a special episode in being rather longer than normal – there is so much to be discussed as the sector is very active right now and the future is busy taking place with lots of seismic shifts happening beneath our feet.
We discuss a whole variety of topics as we kick the four tyres around the car – Lendinvest; penetrating the subsector’s opaque/confusing terminology; understanding the risks; and the future of the industry.
In editing the podcast (which means I listen to it many times) I progressed my own thoughts on how I see the risk in P2P and how to describe it simply. So for the avoidance of doubt I put the risk thoughts in a “Postscript” section down below to make it obvious that these are my afterthoughts and language (Christian’s comments are in the podcast). However I think that the terminology will be helpful in listening to the podcast so it’s not an “unrelated” mini essay 😀
Lendinvest
In the AltFi awards Lendinvest was ranked as the best UK fintech-real estate platform (which has done over £166m of deals to date). Recently I heard a leading Fintech analyst describe them as the best dark horse bet for London’s first major fintech IPO. They have grown organically from being a “non-digital” real estate lending business to the world’s largest real estate platform. And all of this without raising any VC money.
Since 2008 they have returned (in one incarnation or another – more on that in the show) over 6% to investors via secured short-term bridging loans (1mt-1yr) with LTV’s (loan-to-value ratios) of around 60% and no capital losses. More recently they have added a 1-3yr buy-to-let mortgage product.
Lendinvest also have a (relatively?) unique twist to their business model in that their (financially separate) fund management company Montello pre-funds/underwrites the deals they list on their platform. In other words they put their money where their mouth is – if no investor buys that asset Lendinvest’s sister company is left holding it “themselves”.
For the borrower this means there is no uncertainty as to whether a loan will be funded (whereas on a typical platform they have to wait to see if it gets funded). For the lender its a whole extra dimension of confidence above and beyond “we rate this X” – rather it’s “our sister company has already bought this asset – that’s how much confidence we have in it”.
A recent bank line application led to the bank’s Head of Credit saying that Lendinvest’s credit quality procedures (that the bank audited) were better than the bank’s 🙂
Towards the end Christian explains more about, not just Lendinvest’s history, but also their direction going forwards – in particular their investment in tech to improve deal origination, credit and the time it takes to offer a buy-to-let mortgage (currently around two weeks, hoping to move it to a matter of days (which is of course tremendous compared to the banks processing time))
Opaque Terminology
Shakespeare may have been right about the fragrance of roses for more abstract matters naming is everything – the words we use condition our thinking – a point marketers spend years studying in degree courses.
If I said to you “do you want to lend money to dozens of folks you have never met so they can splash out on a new car, have a fancy wedding, get a house extension etc, and you will have no security?”, you might think one thing.
If I said to you “do you want a team, who are incredibly motivated to make a success out of your investment, and who have got a brilliant credit track record over a decade, including one of the worst recessions ever, to invest your money in consumer finance and get you a return ten times what you get from a bank?”, you might think another.
So words are important. What else do we speak and write with?
In LFP010 “The 3,000 feet overview of Alternative Finance”, Rupert Taylor mentioned how he dislikes jargon which serves only to (1) form a barrier between insiders and outsiders and (2) a block to understanding. He also mentioned that there is no commonly agreed definitions in the sector (I am sure I saw the FSA include P2P within crowdfunding recently (?!)). Language also (3) leads to groupthink (which is a factor in many FS risk disasters in the past decades/centuries).
Peer-to-peer is originally a tech phrase which describe a de-centralised network (in contrast with client-server architecture all “peers” are both “clients” and “servers”). Napster was really peer-to-peer in this sense.
If you look up “P2P” on Wikipedia right now it doesn’t have any reference to Alternative Finance! [Note to P2PFA edit that wiki page?! :-)]
As if to make matters worse, following on from using phrases like peer-to-peer, the sector is now taking up the (very tech, very VC) term of “marketplace lending”. This is in large part a “valuation play” – “marketplaces” are more highly rated and there are billion dollar IPOs coming in the US .. so the #OldFS hype machine is busy.
Now once again I don’t feel that this is a widely comprehensible term, nor do I feel it’s accurate – eBay is a marketplace – which to me means that plenty of folks can come and sell their stuff and plenty of folks can come and buy. We discuss this term – Christian is a fan and I am not. You can form your own opinion 🙂
Another term we don’t discuss (but it came to me many times when I was when editing the audio) is “exchange” [and coincidentally today I heard Ron Suber President of Prosper describe themselves as “an online exchange for consumer credit” which I thought clear, simple and with the right implications (after all compare and contrast two exchanges – the London Stock Exchange and AIM – it’s clear which is a more reliable market)].
Most importantly I don’t think any single term can cover the disparate models in P2P right now (see below in the Risk comments). For investors my advice is both to dig below any label and not to read too much into any label.
“Alternative Finance/Online-lending&borrowing” is something that (a) never existed before (hence no vocabulary to fit it) and (b) is evolving over time (hence a label that worked last year might not next).
THE FUTURE – Where the P2P Industry is Heading
The US model is much more institutional and “marketplacey” – hedge funds for example being well able to make their own credit decisions (assuming they can “see through” to the asset). The UK has to date been much more of a “savings substitute” design (lower yielding, minimal losses on the top platforms).
In the US the market has been heavily regulated (enabling a few platforms to grow very large and their owners very wealthy (sound familiar?)). Lending Club alone is forecast to do perhaps $10bn of business next year – more than the entire UK P2P industry put together.
In the UK regulation has been light touch, it’s easy to enter (maybe even “from your bedroom”). Both the government and the London Mayor’s office have been a major part of the 2014 promotion/hype – talking of vocab … take your pick 😉 – of Fintech as a whole. The government has been a heavy supporter not just in terms of considering including P2P assets as viable ISA investments but also in terms of investing tax payers money in deals via some platforms.
In the UK there are a lot of players ~150 in the P2P Finance Association – even Christian who is full-time in this sector and attends many conferences doesn’t know many of them.
A “Goldilocks” growth curve is very important – not too hot, not too cold.
P2P is still a tiny portion of the market (eg the UK mortgage market is £1.6trn) and therefore unlikely to be constrained in terms of quality asset acquisition in the near term. So “external” constraints aren’t that significant right now.
However internal constraints are always significant – Fintech is not Tech – you are dealing with people’s money. There will be a spectrum across P2P of how automated the process can be – more automatable in consumer-P2P due to big data? less in real estate as one needs “boots on the ground” eg re valuation. Where there is manual intervention – especially around credit (far more common in the UK than in the US) – you can’t “just add another server” – “adding another person” takes longer to do well.
To wrap up the show Christian outlines the rosy scenario, the downside scenario and his central scenario – you’ll have to listen to find out the details but his conclusion is “there is a rough ride ahead but the long-term viability of the concept is very real”.
Everyone has an important job in deciding how the market evolves. Platforms; regulators/industry associations; the government and last but not least the investors – caveat emptor 🙂 – plenty of real opportunities out there for great risk;returns – but be wise!
Personal Afterthoughts – Rewording the P2P Risk Debate
These comments are all my own – even if all being inspired by listening to our conversation. Whilst we touch on a number of these topics in the episode these are my afterthoughts.
The industry is very focused (correctly) on credit analysis. However personally – as an outsider (mind you if I am an outsider I wonder what the average member of the public is) – I feel it is less easy to ascertain all the risks the investor takes.
In a sense this is a question of evolution. Historically the main platforms have done an excellent job of risk management – I don’t wish to question that for one minute.
However going forward – especially given the possible ISA flood – can we be certain that all platforms will do as good a job?
My view of FS as a whole is that on the one hand much of #OldFS needs to wake up to an epochal shift. On the other much/most/all of #NewFS needs to get ever more professional/solid/reliable over time.
What happens, post ISA-flood when a hundred or more platforms are listed on a consumer “price comparison website”? Hard to see how one avoids a whole tsunami of unsophisticated investors being attracted to the biggest headline rates rather than assessing quality.
On a price comparison site one could see headline rates and volumes perhaps. But what about the platform risk/quality? Clearly not all platforms are as strong/good/reliable – you name it – as each other. How would one even assess a simple red/amber/green measure?
In LFP006 I discussed this problem over the lack of quality assessment on price comparison sites in the insurance marketplace. Price comparisons websites are just that – they compare the prices of your insurance. They do not compare the quality of the insurance (you only find that out when you claim).
That the public is rate-driven we know – witness in 2008 how many people had money with Landsbanki in the UK (as it had had the “best” rates in the market). Few folks are able to assess the risk of banks or platforms. Even banking analysts don’t have a great record of predicting demises .. just to name a few – Barings, Bankers Trust, Lehmans, Landsbanki were all (as far as I recall) unheralded by the analysts.
RISK I/II – Asset Risk (Principal) vs Platform Risk (Agent)
What the use of the term P2P is trying to convey is that the investor ends up with a direct exposure to the underlying loans. I get that. However there are less obscurantist ways of doing that 😉
Arguably the “peer-to-peer” phrase itself distracts one from the central role of the platform.
To me this is the most important point – vocabulary apart – AltFinance-borrowing&lending is absolutely not “disintermediated”. The role of the platform as an intermediary/agent is absolutely central, absolutely vital.
As Christian says all of the (sensible?) platforms have segregated client bank accounts (and one assumes a settlement mechanism re investing in the loans which means you are not on risk to the platform (not discussed)). So you shouldn’t have a direct cash-asset risk on the platform.
However even though you end up with a principal exposure to the specific loan-asset(s) you also have an agency exposure to the platform.
What do I mean by agency exposure? Well let’s assume you have a holiday home abroad which you rarely visit. The general solution is to have some agent looking after it for you. And if they do that well your asset remains in good shape. However if the agent goes bust or disappears your asset is more exposed to deterioration as any problems that arise aren’t addressed immediately etc.
This agency role is far more vital than say an estate agent – when you buy a house you see it, you decide if you want to buy it and you get an independent survey, valuation etc – so you have little exposure to an estate agent as such (and none post-purchase).
All (?) platforms accept their agency responsibilities – and will live or die by their ability to – source quality deals, filter out fraud, service payments flows, chase late payments, work out defaults etc etc etc.
Owning assets (secured (0.00001% of 1 Park Lane or unsecured loans (£70 to Mr Bloggs1-100)) is one thing if you have a platform there fulfilling all the agency responsibilities.
Even if technically your asset exposure doesn’t change if a platform disappears your asset servicing (“agency”) exposure certainly does.
It would become a huuuuuge hassle to start collecting yourself on all those loans etc – in fact in the general case it would be inconceivable (and by definition you couldn’t do it as well as the platform, especially as, in most cases, you would become just one of many many tiny creditors).
If we fast forward many years to the first platform to fail, in practice the “book”/”portfolio” would have to be transferred (/sold) to another platform to fulfill the agency duties.
Maybe this agency risk is obvious to some of you (it wasn’t to me despite watching a whole host of conference videos!). However as Christian points out whilst the industry (of course) loves volume figures and does publish loss rates, all too often it doesn’t publish and measures of platform profitability or other measures of financial viability/longevity. So how can you assess this agency risk?
This is clearly key. Especially now loan terms are increasing (out to 5yrs) I, having worn a number of FS Risk hats, certainly would not invest any money of that term without assessing my agency risk exposure over that time horizon to the platform. And don’t forget these platforms are not covered by the Bank Deposit protection scheme, nor do they have an industry guarantee scheme (unlike eg travel agents and ABTA/ATOL).
If you are an investor who is considering investing in all 100++ P2Ps but first you want to select which ones to rule in and rule out, it is essential to measure this “agency risk”.
Firstly what is the chance of the platform running into financial problems? I absolutely don’t know myself – but generalising from Fintech as a whole – most Fintech startups are not going to survive.
Secondly what is their equivalent of “banks living wills”? That is, in the worst case of the platform falling over, do they have a new agent lined up? I believe in Lendinvest’s case Montello Capital (a related but separate company with experience of loan servicing/agency duties) would step in as the fallback/”safety net” agent.
Based on a quick straw poll of P2P websites I just checked “not everyone” (being polite) has such arrangements. Some P2Ps merely have vague comments saying the servicing fee should be enough for you to pay for someone else to service your assets.
I am not making these points merely to be critical or to throw rocks at other people’s greenhouses. Rather I am:
(a) trying to help lenders understand the risks they are taking and flag up due-diligence issues to consider; and
(b) trying to help the evolution of Fintech as a whole, but in this case P2P by flagging up my perception of how to make them even more solid and robust than they are right now.
RISK II/II – P2P Two Main Subtypes – YOU select your asset(s) or THEY select your assets
Revisiting the vocabulary point – no single term right now meaningfully covers all of Fintech hence the subsectors.
Nor does any term now cover all the “P2P” subsector. There are many models within P2P. If we ignore the “shades of grey” and simplify into a black and white schematic we could say that “P2P” (the debt subsector of AltFinance) has bifurcated into two main subgroups.
Both approaches are perfectly valid – however they are sufficiently different to explain the fact that no single term fits both.
One type of “P2P” is the P2P/You-Select subtype (eg Lendinvest). They are (somewhat) like a marketplace – or perhaps more like a shop that sources all the things it sells. The platform’s main role re principal risk is, like a stock exchange perhaps, to be a quality control on the individual assets “sold in the shop”.
The other main subtype one might call P2P/They-Select. They are (somewhat) like a fund (albeit neither structured nor regulated as such). In this case your agency exposure is much greater as they are making your principal investment decisions for you. One key difference with a fund is that in some cases there is no transparency – ie you may legally own a bunch of loans (or rather parts-thereof) but you have no knowledge of them, and no auditing that you would get if you invested in a fund.
There are further bells and whistles in that some “P2P-They-Select”s may run provision funds, take out insurance, run “rolling 1mt investments”, have “rate promises”.
There is a further agency wrinkle that touches on principal (which we don’t go into) around liquidity – how easy is it on various platforms to get your cash back before the term of the asset? The agency role there gets very close to your principal risk bone if you need to rely on the agent to (effectively) re-sell your asset. One for another day – and I have written faaaaar too much lol – am sure next to none of you made it this far 😀 – but wearing my old bloodhound hat I would want to sniff some of those quite hard to ensure that principal risk on any given platform hasn’t slipped back in.
Did anyone read all of this?
Say hi if you did 🙂