We've looked at the P2P lenders from the perspective of borrowing - but how about if you want to invest?

By David Hargreaves

Less than two years ago there were none. Now there are four.

Yes, as we've seen, that’s how many licensed peer-to-peer (P2P) lending businesses are now up and running.

While new ways of borrowing money are always welcome (and you can read our article on P2P from the borrowers' perspective here) you can argue that the more vital contribution P2P is making to the financial scenery at the moment is in its adding to investment options. With interest rates continually, it seems, heading toward the floor, the options are many for the borrower.

But what if you've got a bit of cash you would like a decent return on?

Jaded would-be investors, cowed by viewing a constant diet of sub-4% term deposit rates can give their sore eyes a rest by casting them on to double digit rates of return potentially being offered by some of the P2P operators.

The risk is, of course, that there is a risk. You are lending your hard earned directly to someone else. And they might not pay it back. However, unappetising rates of return might look with the banks, you do know with absolute certainty that you would get your principal back.

Ah, but what is life without risk. The other point about P2P investing is that, potentially, it’s actually a bit of fun. I hasten to add that nothing in this article should be taken as investment advice - I'm not an adviser and I'm as new to this P2P stuff as the next person.

I will disclose an interest early here and say that – as a bit of the aforementioned fun – I early last year invested a four-figure sum with the first P2P cab off the rack Harmoney.

I don’t wear my heart on my sleeve, so won’t be disclosing hard dollars and cents, but for the record, I will say that so far my borrowers have been keeping up to date with their repayments (though hold the phone, I see just at the moment two are in arrears) and since last March I’m showing an annualised rate of return somewhat higher than Harmony’s platform average, currently, of 12.66%.  What that tells me is that I’ve (inadvertently) taken on rather more risk than I really intended to. And to that extent I would caution new players (do as I say, not as I did!) not to go at investing your money like a bull at a gate and if the right kind of credit worthy investment is not available at the time you look then be prepared to wait. (I wasn’t!)

Still, at the moment all is well and as I long as I don’t dwell on the fact when I’m trying to sleep at night that there are some people out there paying nearly 40%!!! for the pleasure of accessing some of my money, it is, as they say, all good.

But the P2P scene is now much more than just about Harmoney. Already there’s an encouraging diversity of options available. I've pulled together some of the key differentials between the operators in the table below. Also note that the Financial Markets Authority, which approves P2P operators, has this brochure available.

From my experience so far - and bearing in mind it has been limited to just the one operator, there are a few issues that come to mind. I personally find it a bit frustrating when borrowers repay early (and it tends, from my experience so far, to be the higher-rated borrowers). There's no penalty to the borrower, while you as the lender then have to go back and reinvest that money. Frustrating if you are an essentially impatient type like me. Then there's the whole question of what you should know, if anything about the people you are lending to. And there's some marked differences in approach emerging here between some of the operators.

So, with some of these thoughts as a cue, I put the same set of questions to each of the four operators and below are the responses I got. Thanks very much to all four for taking part. I've listed the responses in alphabetical order.

First up, here's what Harmoney said:

There are now four P2P operators offering a variety of different investment options. What particular advantages/services/investment options do you think your company has over the others and why should investors choose you over the others?

Harmoney pioneered p2p lending in New Zealand and remains the only platform of scale. Most importantly that scale has been planned and we delivered to that plan.   For example, openly stated that our first year target was $100m in lending and we achieved that in 50 weeks and we are on track to lend another $100m just 4 months later. Investors are currently getting 12% “RAR” Realised Actual Returns on the Harmoney platform on average, results vary of course check out our marketplace statistics page at https://www.harmoney.co.nz/investors/marketplace-statistics

Firstly, Harmoney has always seen the competition as more traditional places for fixed interest such as Bank Term Deposits (low risk to investors) that attract the lions share of dollars invested offering low risk but also low returns. Harmoney's 3,500 + active retail lenders take the risk of loans not paying back but enjoy gross returns from 9.99% to 39.99%, Harmoney's actual realised returns is currently 12% on average at 22nd January 2015 after all of Harmoney's fees and all actual written off loans have been deducted - after just over a year in business! Harmoney offers a range of marketplace statistics here market stats.   See our marketplace statistics page at:  https://www.harmoney.co.nz/investors/marketplace-statistics

Scale is critical for any marketplace, choice of loans to invest in, brand, investment in the platform, engineering investment, attracting a great team, borrowers and investors to our marketplace and wider community. 

Secondly, the marketplace itself for the experience of borrowing or lending. Most importantly the empowerment to understand, choose and manage the risk you want to take as a lender for the return that you want. 

Thirdly, Harmoney offers 30 Credit Risk grades to choose from, each individually priced and every loan fractionalised down to $25 so that you can invest in many loans, choose your risk and finally manage to the return that you want. Challenging to build and operate, marketplace lending platforms offer transparency, risk rating and fractionalisation. 

Whereas banks stand behind their lending to the extent of their balance sheet, peer to peer lenders do not, the investors on the platform take the risk of the loan not being paid back. There are different ways of managing or packaging that risk but it is still borne by lenders. Banks manage their products by having large and diverse borrowers, fractionalisation brings that ability to be able to diversify widely which enables a more stable return. 

Lastly, look for a team with specific knowledge for example the Harmoney team started a Personal Loan business in NZ in 2002, created credit models from scratch and lent $1.6b to Kiwis over the following 5 years. Lending is easy, it is getting the money back that is hard!  Our team has a credit in its DNA and this is critical.

What is your attitude to institutional investors versus personal investors? 

Personal Investors or our Lenders are the soul of our business - that's why Harmoney was vision was to offer a marketplace where the risk and pricing is open, transparent and therefore manageable.  

Grading loans through 30 grades and fractionalising them down to $25 is challenging to say the least so we have picked probably the hardest business model for Harmoney in terms of the number of transactions we manage but we firmly believe the most rewarding for our Lenders as you have choice and if you want to you can see almost as much data the bank sees in making a loan decision before you invest. We will be constantly investing and building out functionality in our marketplace c. $35m in capital invested by our personal investors to date. 

The alternative is some sort of fund structure, this would be cheap, quick and easy in comparison but Harmoney has and continues to build out the complexity so there is a global benchmark of transparency within our marketplace whilst also working on providing tools to simplify and automate the experience over time so our Lenders and Borrowers get to choose. 

Do you believe that having a mix of both gives personal investors the chance to get the best investments?

Absolutely, institutional investors offer a number of key benefits for Retail  (personal) Lenders. All the major platforms globally have institutional investors on their platforms - generally it takes 3 to 5 years to achieve this, Harmoney was able to prove up our credit models to such a degree that we achieved $100m lending capital before we launched the platform, a world first!

The very first advantage is their understanding of Credit, Risk, Fraud, Compliance and Funding. All institutional investors are pro-active in completing detailed Due Diligence before deploying lending capital - how would retail lenders be able to achieve this level of peace of mind otherwise? 

Retail Investors shouldn't take for granted a platform's ability to approve the right loans and collect on the money - refer to earlier point, institutions who understand the business of lending intimately generally wait 5 years, demanding 5 years of history before providing funding to platforms.   We had $100m before even launching - thus the quality of our credit model.

Very important point is that institutions provide standby Lending Capital that means investors don't get "Cash Drag" waiting for loans to fill up and for borrowers get their money in a reasonable time also. 

The second advantage is in Harmoney’s marketplace Retail Lenders pick and choose their investments whereas all our institutional funders take the index ie they can't pick and choose.  Institutional lenders follow retail lenders investing in the same loans for the same interest rate and risk.

For example, two Kiwi “Challenger Banks” provide wholesale facilities - Heartland Bank for example provided a $50m lending facility pre-launch. Harmoney deploys the facility under a mandate for institutions so an individual lender providing $25 for a Personal Loan would be followed by our two funding banks - on the same gross interest rate and in the same risk.  

Having a mix also enables us the opportunity to deliver and fund loans for our borrowers with speed i.e. 95% of our loans are funded within 24 hours.

What is your attitude to investors having detailed information about the borrowers and do you think investors being able to contact and ask questions of the borrowers is a good idea?

Harmoney runs a p2p online marketplace and there should be as much information as possible accessible on demand that would reasonably help retail investors choose whether or not to invest in a loan. Now that doesn't mean that Lenders need to look at every loan they invest in but they should know if they wanted to the information is there. 

Peer to Peer Lenders should be using their platforms to deliver rich data and insights wherever possible, putting Lenders in control. Again, the bar and challenge to get this done is high and tough - the Harmoney team is working tirelessly on constant improvements to improve in this regard and always will be! 

Direct contact between Lenders and Borrowers needs to be managed carefully. Identities must remain confidential, otherwise we could see some Lenders being pro-active in collecting their money in their neighbourhood!

Is allowing borrowers to pay back their loans early without any penalties in the best interest of investors? 

Yes, being repaid is always a good thing! Better to worry about late and no payers than early payers! Loan Terms are the maximum number of months the borrower will repay rather than the term of the investment. Borrower fees are highly regulated and the opportunity for fees would be unlikely to be of sufficient quantum to put those that want to pay off early off doing so. Keep in mind Harmoney and our retail lenders provide a benchmark Personal Loan product to borrowers where rates and fees are fair, honestly represented, fully disclosed without any sneaky business. 

What course of action do you recommend to investors faced with fairly high numbers of early repayments?

Welcome early repayments as a crucial and fairly standard way of doing business when building a loan book, keep in mind that you are building a portfolio and your early repayments mean the borrower has paid back or they have taken another loan, paying out the original loan for a higher amount and these offer an investment opportunity in the marketplace. Yes, early repayments dampen returns a little but overall lenders need to ensure that the rate you are getting back compensates for the risk. 

Lenders should not lend unless they are thinking of building a portfolio across many loans. Some investments in some loans may not get the return hoped for. There could be many reasons for this but perhaps the most common are early payment or no payment by the borrower. Some platforms might hide these facts in someway but they remain intrinsic to building a loan portfolio. 

Anything else you want to add?

Four different platforms with different offers in the Peer to Peer lending vertical is very encouraging. The peer to peer value proposition is extremely strong if offered in the right way. 

Harmoney is building the complex and hard first, we haven't always got it 100% right, but the passion of our team will enable us to reach the high bar set for us by our community. Harmoney's goal is to be the best at getting better with our counterparts such as Lending Club, Prosper, Funding Circle or Zopa. 

Harmoney hopes to positively and meaningfully increase the wealth and prosperity of our entire community in a meaningful way and are feverishly working very hard toward that goal. 

$200,000,000 of lending to Kiwis in just 15 months is amazing, our lenders have adopted early, embraced the Harmoney platform and given us the privilege of a start! The Harmoney team is determined to deliver a benchmark platform and experience in return - it is a long and hard journey, to hit the standard we all aspire to with a fraction of the investment our European and USA counterparts get, but hopefully a worthwhile and rewarding journey. 

So, thanks for the help, support and passionate feedback from all our borrowers and lenders. 

Next up is Lending Crowd:

There are now four P2P operators offering a variety of different investment options. What particular advantages/services/investment options do you think your company has over the others and why should investors choose you over the others?

Lending Crowd - advantages for investors

-         The only peer to peer company in NZ whereby the Directors have successfully navigated the Global Financial Crisis and have a long and “proven history” of dealing with both borrowers and investors. I.e. The LCL Directors are the same as existing Non Bank Deposit Taker 16 years established- Finance Direct Limited

-         100% of Lending Crowd loans have security of either a car, caveat or mortgage or combination of all. I.e. Therefore investors have the comfort of knowing that asides from robust risk mitigation systems that all borrowers have skin in the game.

-          Lending Crowd does not charge its investors fees on principal and interest payments. Lending Crowd aligns its interests with the investors and only earns its money as a percentage of the “interest” earned by the investor. Therefore if no earnings for an investor then there is no earnings for Lending Crowd.

-         Very simple investor registration system than allows both individual AND institutional investors to bid on borrower loans on-  EQUAL TERMS.

-         Lending Crowd is the only P2P Lender in NZ to target Small to Medium sized business loans and this offers the investors a quality asset class to invest in as these loans are normally reserved only for the big trading banks to invest in.

What is your attitude to institutional investors versus personal investors? Do you believe that having a mix of both gives personal investors the chance to get the best investments?

We believe that as long as private investors and institutional investors invest on exactly the same terms then this is a positive outcome for personal or smaller investors. Firstly the personal investors have the comfort of knowing that institutional investors would not commit large sums without a very high level of due diligence. Secondly institutional investors allow borrower loans to be originated or fully funded quickly and this is essential for the credibility of the system and means personal investors can be assured the loan will proceed.

What is your attitude to investors having detailed information about the borrowers and do you think investors being able to contact and ask questions of the borrowers is a good idea?

Our view is that ALL investors should have a comprehensive view on the risk of the actual loan they are investing in the form of a “loan listing”. We are not a fan of unaudited Provision funds that socialise losses or hide the risk profile of an individual borrower from the investor who put their money into a particular loan. We believe a loan listing should clearly cover off the security offered, capacity to repay, stability and risk grading of the applicant. We are not in favour of investors contacting borrowers directly as it creates unnecessary noise in a 100% online system and furthermore in our view it would only cater for a very small number of curious investors who would be interested anyway.

Is allowing borrowers to pay back their loans early without any penalties in the best interest of investors? What course of action do you recommend to investors faced with fairly high numbers of early repayments?

Firstly Lending Crowd investors are not penalised AT ALL for early repayments or top up of existing loans. Lending Crowd we will NOT take a clip of investors “principal” and only earn its money from the investors earnings  Our recommendation to investors is to always keep their funds invested and earning interest. Don’t worry about loans being settled early or refinanced with Lending Crowd as this is a natural feature of consumer and SME loans and considered healthy and investors should make sure that like Lending Crowd that other P2P lenders also have systems to ensure overdue or defaulting loans are not being topped up or refinanced back to new or existing investors. Compensating investors by penalising the borrowers for early repayments is not the answer and goes against the ethos of Peer to Peer lending. Furthermore investors should be mindful that at some point in the future with the exceptional rates on offer through P2P that they may want or need to be a borrower.  

Anything else you want to add?

We know from experience that retail investors have a low appetite for risk and as P2P loan books mature i.e. in 2 to 3 years OR maybe another global or local financial shock occurs then we believe it will become apparent what P2P model is the most robust for investors. After all its not until the tide goes out that you find out who’s swimming naked.  

Lending Crowd has created a very easy 100% online service for “secured loans” all designed to offer fair above market returns to investors and at the same time significantly drive down the cost of people borrowing money. Developing an unsecured platform like Harmoney and Squirrel for consumer loans and SME loans would have been a lot easier for us however we inherently understand that NZ retail investors have an exceptionally low appetite for risk and the loss of their capital. The objective of Lending Crowd is to over time build the trust of all investors but in particular retail investors. This will be achieved by offering fair returns but with bank grade risk mitigation.

Now LendMe:

There are now four P2P operators offering a variety of different investment options. What particular advantages/services/investment options do you think your company has over the others and why should investors choose you over the others?

First and foremost, our main point of difference is our focus on secured lending. Although others may state that they will do some secured lending, we don’t believe they are ensuring that the security will adequately cover the risk associated with a loan in the way that we are. All of the loans facilitated to date (approximately $1m of lending) have been backed by 1st mortgage transferred into a bare trust for the lender. Additionally, we have ensured appropriate general security agreements and adequate insurance cover over all security are taken. This, we believe, is what enables lenders to have a far greater degree of confidence to lend larger amounts and for us to offer a higher lending ceiling to borrowers (up to $2m). By way of example of the care we take to protect our lenders, in a recent loan we facilitated, we had to ensure that the property used as security had adequate water rights (which were initially missing) so as to enable appropriate insurance cover over the property. This was an oversight by the property developer, and through our attention to detail we were able to have this issue resolved in advance of drawdown so that we could be 100% certain the investor had adequate and complete security backing their investment.

As highlighted by the above example, a key differentiator for us is the experience of our team. We have credit managers who have approximately 40 years of banking experience each. This is invaluable when it comes to analysing any loan application, and the relationship between the loan to value ratio of the security and a borrower’s willingness and ability to repay their debt. All of this experience is brought to bear on every loan application, as we don’t feel it is appropriate to rely on an algorithm-based approach only. Particularly as one of our credit managers works with every loan applicant to structure the loan to minimise lenders’ risk while ensuring the best possible deal for the borrower.

What is your attitude to institutional investors versus personal investors? Do you believe that having a mix of both gives personal investors the chance to get the best investments?

To date, we have focused solely on personal investors. We want to make sure we are providing a genuine opportunity for peer to peer lending to succeed in the first instance. Our tag line is ‘kiwis funding kiwis’ and we have been true to this so far. Moving forward, we want to continue to provide a significant amount of opportunity to personal investors. With uncertainty in global stock markets, including our own, and continuing poor returns from bank deposits, we want to provide a genuinely safe opportunity for kiwi investors to be able to take advantage of LendMe loans. Given the great returns investors will receive, backed by security, we would love to see kiwis prosper by making funds available to other kiwis at fair rates of return given the risk of each loan. We will however be open to some institutional investors in the future, as we would not want borrowers to miss the opportunity to obtain funds for the things they want and need. At this stage however we are still strictly peer to peer.

What is your attitude to investors having detailed information about the borrowers and do you think investors being able to contact and ask questions of the borrowers is a good idea?

When borrowing through LendMe, borrowers will have the option to disclosure varying amounts of information about themselves. The first level is full disclosure where everything is shared with potential lenders except for addresses and contact details. We believe that this level of disclosure will provide lenders with a greater degree of confidence about investing in a loan. Partial disclosure will mean that borrowers’ names, addresses and contact details are removed. Because we believe that this will increase lenders’ reticence to invest somewhat the borrower will incur an additional 0.5% loading on the interest rate. And finally, borrowers can opt to be anonymous. This will mean that only high level loan application details are released to potential lenders – such as loan type, amount, LVR, interest rate, reason for borrowing, etc. In this final example no supporting documentation will be released to lenders. We believe however that this will increase potential lenders’ reticence (potentially significantly) to invest in a particular loan and so this incurs an additional 1.0% loading on the borrower’s interest rate.

To date, we have found that lenders seem more confident to lend to people in situations that they understand. So, it seems that farmers may be more willing to lend to other farmers, and even people from a particular region seem more comfortable to lend to people in their own region (or a region they know well). With this in mind, we believe that lenders being able to ask borrowers questions will help bridge the divide in some instances. Not everyone will necessarily want to do this, because the information about the loan will stand up on its own. We believe however that there will be questions that lenders may want to ask regarding a borrower’s situation that could be the difference between deciding to lend or not. Additionally, experience from others abroad has suggested that borrowers who have been directly engaged by the lender are less likely to default. Given our short trading history, we are yet to put this to the test in NZ however.

Is allowing borrowers to pay back their loans early without any penalties in the best interest of investors? What course of action do you recommend to investors faced with fairly high numbers of early repayments?

Allowing borrowers to pay back their loans early without penalty provides a significant differentiator with the banks. Of course if a well performing loan is repaid early then this will mean that the investor doesn’t have the opportunity to take advantage of that loan for its full term. However, I would consider this a significantly better outcome than default. Should a loan be repaid early we would be recommending lenders to identify a new loan to invest in. At this stage, we don’t anticipate high numbers of early repayments as we work with borrowers when they apply to set the ideal loan term given their financial situation.

And, finally Squirrel Money:

There are now four P2P operators offering a variety of different investment options. What particular advantages/services/investment options do you think your company has over the others and why should investors choose you over the others?

We are the only P2P Lender with a Reserve Fund that protects investors from credit losses.  We are the only P2P lender with market-based interest rates that change depending on supply and demand.  For borrowers we have the lowest fees and overall the lowest interest rates and we generate a healthy return for investors of around 9.00% with a reserve fund to protect against expected defaults.

What is your attitude to institutional investors versus personal investors? Do you believe that having a mix of both gives personal investors the chance to get the best investments?

We don’t use Institutional Investors.  Peer-to-peer is supposed to be disrupting the market (or dis-intermediating) for the better of borrowers and retail investors.  Offering them something they otherwise can’t get.  The types of early institutional investors are credit fund managers who are looking for abnormally high returns.

What is your attitude to investors having detailed information about the borrowers and do you think investors being able to contact and ask questions of the borrowers is a good idea?

It’s not practical.  And if you’re trying to invest say $100,000 into fractions you simply don’t have time to drill into too much detail.  Some investors will do due diligence and analysis and be well informed in their decisions, but many won’t really know what they are doing.  To suggest that all retail investors are astute credit managers or portfolio managers is a big stretch.

With our platform we take responsibility for credit decisions and the platform’s performance rides on those credit decisions.  We put our money where our mouth is and underwrite the platform at 4.00% for the first 12 months.  We are the only P2P Lender with a Reserve Fund that protects investors from credit losses.  If a borrower misses a payment then the payment is covered by the Reserve Fund and the investor is still paid.  This gives investors certainty of return and the simplicity of not having to do hundreds of loan fraction to diversify.  The Reserve Fund is continually topped up by part of the borrower interest payment.  We are current reserving at 2.50% against expected credit losses of 1.50%, so the Reserve Fund will increase in size over time.  

Is allowing borrowers to pay back their loans early without any penalties in the best interest of investors? What course of action do you recommend to investors faced with fairly high numbers of early repayments?

Repayments are inevitable with lending and with personal loans in particular.  We don’t charge the investor a fee based on the amount repaid, so there is no cost to them when a borrower repays.  This is different to Harmoney which charges its fee on the amount repaid.

Anything else you want to add?

The obvious thing is what happens when we have a market correction.  

What if losses go to 10% or 20%?  

Depends on who you lend to and how big any market correction is.  Throw away numbers like this lack any analytical rigour.  Why not 50% or 70%?  That’s essentially what risk is all about – understanding the probability of different outcomes.

The biggest correction in modern history in NZ was post 1987 (which got to its worst around 1992) and we briefly had an unemployment rate of 10.7%. Off the back of the Asian crisis in 1997 we briefly hit 7.70% unemployment and then 2012 at 6.90% post GFC.>

The unemployment rate tends to hit lower skill occupations more and one industry towns. During the GFC companies were reluctant to retrench higher skilled roles as they knew they'd be hard to replace after the correction.  So ... if we (Squirrel Money) are predominantly lending to B-grade borrowers (who have a statistical probability of default of around 1.50%), live in metro areas, have an average income of $87,000 (mostly PAYE), clean credit records and 46% own their own house - how would we get defaults of 20% even in a market correction scenario?

We are happy to grow slowly and methodically, and are firmly playing in the bank space, not the traditional finance company space. We have no desire to chase high risk loans.

A “B" grade client (majority of our clients) would have a clean credit history and good account conduct and on average an income of around $80,000.  The borrowing rate would be circa 12%-13% unsecured which is about 2.00% lower than banks for a similar loan.  There are plenty of low risk clients out there.  Across the whole population the default rate is less than 2.00%.  People understand the value of having a good credit record.

So if credit losses trended to say 5.00% what would happen?

First as the Reserve Fund began to reduce we’d increase the reserving rate (which would slow down the rate of depletion.)  

As the market got risker the borrowers would pay more.  As personal loans are relatively short term with more than 32% of principal repaid inside 2 years it does’t take too long for price movement to start to impact on the portfolio.  If the Reserve Fund went below 1.00% the trustee could elect to divert more of investor interest to the Reserve Fund (and in essence socialise the loss across all investors.)  If we have 4.00% reserves, maybe higher it would only take 3 months interest to cover the shortfall and investor principal would be protected.

Under our model it is very difficult to lose capital.

Some additional points worth noting.  P2P is not like a finance company in that the money is held in trust for investors.  Finance companies suffer from liquidity mismatch with long assets and short deposits.  P2P is perfectly matched.

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