Banks' personal loans and credit card business in the sights of peer-to-peer lending applicant Harmoney

By Gareth Vaughan

Harmoney's CEO says his company aims to attack banks' most profitable lending business, undercut the interest rates they charge borrowers, and target term depositors with offers of double digit interest rates.

Harmoney is one of the companies intending to apply to the Financial Markets Authority (FMA) for a peer-to-peer lending licence. Neil Roberts, Harmoney's CEO and controlling shareholder, told interest.co.nz in a Double Shot interview banks can't compete directly with peer-to-peer lenders because it would cost them too much, and they'd have to admit the deposit rates they pay are low.

Roberts' previous roles include head of sales and business development at Flexigroup, general manager at Pacific Retail Finance which was bought by GE Finance and Insurance in 2006, and sales manager at AGC Finance. He's Harmoney's 98% owner with the Icehouse having a 2% stake.

"If you look at the credit card and personal loan market, and you look at the banks because this is a competitive play against the banks on both sides of the equation, the big four are the most profitable in the world," Roberts said. "I know that interest.co.nz have recognised that in past articles. And within the most profitable banks on the planet, the most profitable categories are credit cards number one and personal loans are number two."

"In fact in our own assessment, credit cards are 12 times more profitable than the rest of the bank and personal loans are 10 times," said Roberts.

"So the beauty about personal loans is we're attacking a very profitable part of the banks' business, but it's a very simple product that has produced a result for the bank that's near riskless because it's so predictable."

Debt consolidation was planned as a "very big" part of the business, Roberts added.

"Mainly it's getting rid of very expensive credit card debt where people are paying off minimum payments and they've got that credit card debt for a very long time. It's bank rated customers, it's just people who have run up a bit of debt and they want the simple benefit of being able to pay that off in fixed instalments knowing that they'll get to a point where they'll have no debt."

'There's no leverage'

He said the "elegance" of the peer to peer lending business model is there's no leverage.

"So we're not loaded up with debt like a bank," Roberts said. "We have no branch network, we're fully automated with good support behind it. Our costs are a fraction (of banks' costs). In fact we believe the banks can't compete, and can't get close to our cost base."

Peer-to-peer lenders are certainly starting to appear on banks' radar screens internationally. Westpac recently invested A$5 million in Australia's SocietyOne (currently only open to "sophisticated" investors), Spain's Santander has partnered with British peer-to-peer SME lender Funding Circle, and Barclays has bought 49% of South Africa's RainFin. The highest profile US peer-to-peer lender, Lending Club, is now valued at US$3.76 billion ahead of an expected initial public offering.

As a peer-to-peer lender Harmoney would run an internet platform that introduces lenders to borrowers. It plans to offer both secured and unsecured loans. Roberts expects the average investment from retail investors in the early days to be about $5,000. Borrowers by law can't borrow more than $2 million annually.

Roberts said lenders, or investors, will enjoy "full retail rates."

"There's no bank in the middle taking that margin which is exactly what happens when people put their money on term deposit. The bank takes the risk, whereas in our case obviously the lender takes the risk. But we believe it's a predictable risk."

"It's simply that, they (lenders) are enjoying the full retail return. For the first time we have a fixed term, fixed interest product where we've opened up to retail investors the retail rate."

Spreading risk

Roberts acknowledges credit losses via peer-to-peer lending are inevitable. Therefore Harmoney plans to break down loans to $25 lots to spread lenders'/investors' risk.

"So if a borrower applies for $10,000, we'll break that down to $25 lots (from lenders). And we encourage people to take a huge spread of their risk so if any one loan does get into trouble, it's only a very small part of the overall portfolio."

"In doing so we're able to produce retail results net of all cost and net of a predictor credit loss that is in the double digits on average."

That means interest rates paid to lenders, after costs and after credit losses are taken account of, in the double digits, Roberts said.

How interest rates will be priced

Interest rates will be priced via Harmoney's scorecard. A risk grading system features 30 grades ranging from A at the top to G at the bottom. This is similar to how Lending Club prices risk. See Lending Club's pricing details here.

"It's a wonderfully transparent system. You (the lender) get to see, if you want to, the loans, the application, the credit file. The only thing you don't see is anything that can identify the borrower. And you pick which loans you want to invest in," Roberts said.

Harmoney will make money by charging fees through a repayment fee for lenders, and an origination fee from borrowers. The origination fee will vary depending on the credit risk. As Harmoney's yet to apply for a licence from the FMA, Roberts pointed to the fees charged by Lending Club as an example.

"The average is about 4% charged flat to the borrower upfront, so a 10 grand loan is $400. And then on the other side it's 1% taken from the repayments that are made each month, which works out at about half a percent per annum on the amount you have invested," said Roberts.

"These businesses are low margin, but they're low capital and they're low operational cost. It's obviously important to get volume."

The regulations enabling the development of peer-to-peer lending do allow for institutional funding, and Roberts expects to see some of this.

'An alternative investment class going mainstream'

Roberts said he hopes over the next few years peer-to-peer lending will go from being an alternative asset class to something that's mainstream in New Zealand.

"You wouldn't be putting all your investments, or all your retirement money, into peer to peer but you'd be putting an element of it in. The vision is to be part of New Zealand's savings and to keep the banks honest. Because we can start with personal loans, but there are certainly opportunities down the track as you've seen with Lending Club going firmly into that SME market," said Roberts.

"We're hoping people will grow with us, see this for what it is; A disruptive play against the banks."