How much risk are you taking to get your 12pc?
Peer-to-peer lending is booming as returns elsewhere collapse, but can you truly assess the risk? Sam Brodbeck reports
As returns on most assets plunge yet further, the prospects on offer from peer-to-peer investing – now a decade old and having attracted almost £6bn of savings – are more alluring than ever. Annual income of up to 12pc is promised, and the investments enjoy the indirect backing of the Government by being eligible for Isas and pensions.
But is it safe? While other, mainstream lenders pull back in the face of economic uncertainty, is it wise to be lending to individuals and small businesses via peer-to- peer arrangements which in many cases have not weathered a severe downturn?
Here Telegraph Money draws on one of the few credible sources of risk analysis to identify sites that offer the best returns for the least “risk”.
Peer-to-peer (or P2P) bypasses banks by using websites to connect investors, or lenders, with borrowers. Lenders earn more for their cash and borrowers pay less than would be the case with a typical bank. Lending models differ markedly between P2P firms. You can lend to individuals or companies and for a variety of purposes, including loans against property.
There is typically an agreed term, with fees applying if money is withdrawn before maturity.
Specialist P2P analyst 4thWay compares peer-to-peer platforms and has developed its own “stress testing” formulas to gauge the ability of platforms to cope in a downturn. This includes assessing how borrowers would fare – in terms of continuing to make repayments – in a recession of a severity that occurs only once in a century and which involves, for instance, a 55pc crash in house prices.
The tests produce a range of credit ratings, with some P2P firms having different scores where they have different tranches of loan.
Many P2P firms split their loans into their own risk categories, often denominated by letters “A”, “B” and so on, and 4thWay then applies its own grade to each of these.
According to its analysis the highest return available, along with the best stress-test score, is Funding Circle’s 8pc provided through the firm’s “D” business loan tranche.
The next-highest returns are also offered by Funding Circle, through its B and A+ loans, at 7.2pc and 6.5pc respectively.
Of the 11 tranches of loans overseen by the six P2P platforms covered by 4thWay, eight received the highest stress test score.
Funding Circle’s “A” and “C” tranche of business loans and Proplend’s “B” and “C” tranches of commercial property loans missed out on the top score. Investors here could expect to have to wait longer to recoup losses in the case of a serious downturn, 4thWay’s analysis suggests.
The firm explained that the large proportion of high scores was due to the fact that the platforms transparent enough about their book of loans tended to be the more established players.
It warned: “Lenders, like all investors, should always treat
‘If it’s not transparent do not invest at all – or invest less’
‘More investors than borrowers could lead to higher risks’
less transparent investment opportunities with a lot more caution – either don’t invest or invest less.”
While stress-testing is useful, Adrian Lowcock, investment director at Architas, a fund manager, warned that the weaknesses within a market would emerge only after a “full cycle of boom and bust” had completed. He compared the situation to that of the late Nineties before the technology stock correction.
Some platforms hold reserve capital to bail out investors in the event of borrowers defaulting.
Ratesetter has the largest buffer fund of all, at just over £17m, with the firm claiming that this equates to 128pc cover for all the claims it expects to receive. It boasts that none of its 45,000 investors has ever lost money.
At the opposite end of the scale, Funding Circle has no fund against bad debts at all. It said having a fund represented a new risk, of having either too much or too little in it. The platform said spreading investments across different borrowers was a better way to protect investors.
Neil Faulkner, founder of 4thWay, said backup funds were “not essential”.
“If a pot of money is being put aside returns will be lower,” he said. “If you do not have that pot of money you would expect the interest rate to compensate you for that risk. What is essential is spreading your money across lots of borrowers and lots of different P2P platforms.”
Perhaps because of the difficulty in assessing the risk of differing P2P propositions, financial advisers have been slow to bring them to the attention of their investing clients.
Phil Young, of adviser support firm threesixty, said there were also fears that P2P lending was being viewed as low-risk or a “proxy for cash”.
Mr. Young warned that rates of return were drifting down and that demand from borrowers was weaker than that from lenders, leading to some platforms taking on more risk to generate higher returns.
Zopa, the sector leader, has already announced that it will cut the rates across its three accounts by 0.2 percentage points, warning that the industry faced a shortage of borrowers.
“To date, investors have done too well, better than they deserve to, given the risks they have taken,” said Mr Faulkner.
“Rates are coming down, but if you invest steadily and spread your money you can expect satisfactory returns.”
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